Ill i piiiiiiiii; 






§ ! 



ii 



Miiiii hi 



I 



■ i I 



m 



m 
111 




Class _Ai__rjV^ 

Book ,; 

Cop)7ightN^. 

COPYRIGHT DEPOSn^ 



THE CAREFUL INVESTOR 



THE CAREFUL 
INVESTOR 



BY 

EDWARD SHERWOOD MEAD, Ph.D. 

PROFESSOR OF FINANCE IN THE WHARTON SCHOOL OF FINANCE 
AND COMMERCE, UNIVERSITY OF PENNSYLVANIA 




PHILADELPHIA & LONDON 
B. LIPPINCOTT COMPANY 
1914 



M4- 



Copyright, 191 i. 1912, 1913. 1914. by J. B. Lippincott Company 



Published, January, 1914 



FEB 191914 



PRINTED BY J. B. LIPPINCOTT COMPANY 

AT THE WASHINGTON SQUARE PRESS 

PHILADELPHIA, U. S. A. 



©CI.A362624 



PREFACE 

American investors, under our crude and care- 
less methods of finance, have lost incalculable 
amounts of money by purchasing bad securities. 
Not alone has the "get-rich-quick" company 
preyed upon the investor, but hundreds of millions 
have been lost in the bonds and stocks of railroad, 
public-service, and industrial corporations — secur- 
ities often issued under the auspices of responsible 
and respected banking houses, but which, either 
because of defects in the securities which a careful 
preliminary examination would have disclosed, or 
because of bad financial management, have failed 
to come up to expectation. 

Made wise by costly experience, the American 
investor has grown critical in recent years. He 
is disinclined to speculate. He looks for security 
before income. He asks many questions concern- 
ing assets, earnings, the quality of management, 
the strength of franchises, the extent of monopoly 
control possessed by the companies into which he 
puts his money. It is no longer easy to victimize 



PREFACE 

him with junior Hen mortgage bonds or with 
inflated stocks. 

Investment bankers have also learned that a 
reputation for sound judgment as to the value of 
the securities which they offer is their greatest 
asset. Competition for the investors' money is 
growing constantly more strenuous. Salesmen 
are quick to seize upon the weak points in the 
securities offered by other houses. The banker 
cannot afford to take chances by selling bonds of 
whose merits he has not thoroughly satisfied 
himself. 

Out of the growing caution of the investor in 
buying securities, and the desire of the investment 
banker to take no chances as to the quality of 
what he offers, has been developed a body of 
sound financial knowledge which is constantly 
being utilized to increase the security of invest- 
ments. Improvement has proceeded so far that 
it is now possible to offer the investor thoroughly 
safe bonds which will yield a much higher rate of 
interest than was, until recent years, thought con- 
sistent with security. 

This book, the outgrowth of a series of magazine 
articles which has followed a fairly consistent 
plan of arrangement, aims to present some of the 



PREFACE 

accepted opinions as to what constitutes a safe 
investment. The author claims no special ability 
in indicating soimd investments, but he is con- 
fident that close adherence to the cautions laid 
down in the following pages will keep the investor 
from buying investments which are unsound. 

Edward Sherwood Mead 

Philadelphia, 19 14 



CONTENTS 



CHAPTER PAGE 

I. The Chances of a Lamb in the Stock Market. . ii 
II. Stocks or Bonds 36 

III. The Corporation Mortgage and the Deed of 

Trust, 50 

IV. The Banking House as an Aid to Investors 61 - 

V. The Business of the Investment-Banker 72 

VI. The Reliable Investment-Banker 83 

VII. Public Obligations — Municipal Bonds Pre- 
ferred 93 

VIII. High- Yield Municipal Bonds 108 

IX. The American Railway Industry 115 

X. Railway Labor and Railway Investment 123 

XI. "A Reasonable Return upon the Value of the 

Property Devoted to the Public Service" . . 134 
XII. The Securities of Public-Service Corporations 142 

XIII. The Investment-Banker and the Public-Util- 

ity Company 154 

XIV. The Public-Service Corporation and the City 163 
XV. The Public-Service Commission and the In- 
vestor 177 

XVI. Farm Mortgages 185 

XVIL The Mortgage Bank 197 

XVIII. Industrial Bonds and Railroad Bonds Com- 
pared 206 

XIX. Timber Bonds 222 

XX. Industrial Preferred Stock 232 

XXI. The Dissolution of the Trusts 244 

XXII. The Investor and Gold Supply 261 

XXIII. Price Movements Since 1865 268 

XXIV. Investor and the Future of Prices 275 

9 



THE 
CAREFUL INVESTOR 



THE CHANCES OF A LAMB IN THE STOCK 
MARKET 

Complaints of the extreme dulness in business 
are rife in all stock brokerage houses. The "pub- 
lic'* is not buying stocks. Brokers are reduced 
to the expedient of preying upon one another. 
Meantime expenses continue, and there is no 
relief in sight. "For this condition," said a 
veteran broker, "the muck-raking magazines are 
responsible. They have denoimced Wall Street 
and Wall Street methods so persistently and with 
such violence that the people have come to look 
on the term 'Banker and Broker* with suspicion. 
They do not want to trust brokers with their 
money. They feel that they will not be treated 
fairly. They do not believe that the Wall Street 
game is honest." 

11 



THE CAREFUL INVESTOR 

" Is it honest ? " he was asked. ' ' Are the people 
correct in their opinions? What about this criti- 
cism of the financial game ? Do you believe there 
is anything in it?" 

"Well," he replied, "I'll tell you my own 
opinion. The magazines are right. There's 
nothing in the game for the people except excite- 
ment, worry, and loss. If a man sticks to the 
stock-market game long enough, he will lose. 
While he is playing it, unless he is careful, he will 
be made the victim of some trick of manipulation 
which will take his money away from him, with- 
out even giving him a run for it. Of course, it's 
my living. I like the business. I try to be fair 
to my customers; I know I am honest with them; 
but sometimes, when I stop to think, I'm sorry 
for them. They haven't a chance." 

Such candor is unusual and refreshing. Read 
the solemn editorials in the newspapers when it is 
proposed to abolish or restrict the stock exchange. 
Note the indignation with which any such proposals 
are received. "Without the stock exchanges and 
the brokers," we are assured, "business could not 
be carried on." It is admitted that there are 
abuses. Foolish men speculate to their ruin. 
Occasionally a broker turns rogue, makes a dis- 

12 



A LAMB IN THE STOCK MARKET 

honest failure because he speculated for his own 
account with the money of his customers. But 
these are only incidents. They furnish no reason, 
it is said, to overthrow a great and beneficent 
institution, or even to hamper or seriously inter- 
fere with its operations. Through the stock ex- 
changes capital is mobilized, brought together in 
great masses for railroads and subways. The 
buying and selling of the brokers for their cus- 
tomers and for themselves establishes the values 
of stock and bonds. The stock exchange discounts 
future events. If the com crop is threatened by 
drought, down go the prices of Western railroad 
stocks. Is a trust threatened with attack? The 
stock exchange knows before any one else, and 
the ticker tells the story. Without the stock 
exchange, the banks could not make loans on 
collateral with any safety, since they would have 
difficulty in finding a quick market in case it 
became necessary to sell. 

These are strong statements. They have high 
authority to support them. They are not to be 
questioned without the production of strong evi- 
dence that they are overdrawn. Certainly, they 
will not be questioned here. 

While, however, we may recognize the stock 
13 



THE CAREFUL INVESTOR 

exchange and the members thereof as public bene- 
factors, indispensable parts of the intricate plan 
of things as they are, it is well to look at the situa- 
tion of the man or the woman who makes the 
stock exchange and the brokers possible — the 
margin speculator. It is the speculator who pays 
the commissions. The commissions build the ex- 
changes, pay the rents of the brokers' offices, 
maintain the costly private wires, and support the 
modest establishments of the thousands of men 
who get their living from the business. The bills 
for these are heavy. The speculator pays these 
bills. What does he get for his money? 

First, let us clearly understand the nature of 
margin speculation as carried on through a stock 
exchange house. You, let us say, are a merchant. 
You have a good bank balance or some sound 
investments. You believe that Atchison com- 
mon at par is too low. You think the price will 
advance. You resolve to take advantage of the 
rise. You secure an introduction to a broker. 
How glad he is to see you — especially in times 
like these. You give him an order to buy 500 
shares of Atchison, costing $50,000, for your 
account and risk. 

You do not have $50,000. Your available re- 
14 



A LAMB IN THE STOCK MARKET 

sources are only $5,000. But this is no barrier to 
the transaction. Your broker is also a banker. 
He will lend you the difference between $5,000 and 
$50,000, and will buy the 500 shares for you, pro- 
viding you will leave the stock on deposit with 
him to secure the loan. The purchase is made. 
You give the broker $5,000 in cash or securities. 
He borrows $45,000 from a bank or trust company 
and buys 500 shares of Atchison, as he notifies 
you, '*for your accoimt and risk." 

I once heard a broker describe the resulting 
situation and its developments as follows. 

Says the broker to his customer, or ''client": 

"You own 500 shares of Atchison, costing $50,000, 

and worth $50,000 to-day. Of this $50,000, 

$5,000 is your money and $45,000 is my money. 

Suppose, now, that the price of Atchison goes up 

10 points. Your 500 shares are worth $55,000. 

Of this $55,000, $10,000 is your money and $45,000 

is my money. You have made $5000. Suppose, 

now, that you have had enough for the present. 

You have vindicated your judgment of Atchison's 

value. You have a good opinion of yourself. You 

decide to rest on your oars and take your profits. 

You order your broker to sell. Your account 

with your broker stands like this. 

15 



THE CAREFUL INVESTOR 

John Jones in account with Smith & Company, Bankers and 
Brokers. 

Dr. Cr. 

To loan $45,000 By 500 shares A.T.S.F.$55,ooo 

To interest i month 6 

per cent 225 

To commission % per 

cent 125 

$45,350 
Balance 9,650 

$55,000 $55,000 

The broker now gives you, if you want it, a 
check for $9,650 — ^your original $5,000, and $4,650 
additional. You are a successful speculator. Life 
is sweet. 

Now reverse the situation. Atchison does not 
go up. It goes down. The grasshopper, or the 
hot winds, or the Kansas legislature, or the Inter- 
state Commerce Commission, move on the Atchi- 
son. Atchison common is "weak." It goes down 
two points. Comes now your broker and says to 
you, in effect, something like this: "You own 
500 shares of Atchison. These shares are worth 
today $49,000. Of this $49,000, $45,000 is my 
money and $4,000 is your money." Suppose the 
hot wind blows on, and Atchison goes down three 

points more. Again your broker confronts you, 

16 



A LAMB IN THE STOCK MARKET 

"Your 500 shares are worth only $47,500. Of 
this sum $45,000 is my money and $2,500 is your 
money. I have these shares pledged at the bank 
as collateral for the $45,000 I borrowed for you. 
The bank demands more security. I'm sorry, 
but I must have more margin. About $1,000 will 
be sufficient. " So you give the broker $1 ,000 more, 
and if Atchison keeps on descending, you give him 
another $1,000, and another. You must keep his 
security safe. He must always have $45 ,000 in the 
value of your stock. 

Now, suppose you cannot meet these calls for 
margin. Suppose Atchison goes down 10 points in 
a single day — ^it went down 18 points on May 18, 
1 90 1 — and you cannot raise the money for margins. 
You are sold out. Your broker sells your 500 
shares of Atchison, if he is honest, at the best price 
he can get ; if he is dishonest, at the lowest price 
of the day. He sends you this statement : 

John Jones in accotint with Smith & Company, Bankers and 
Brokers. 

Dr. Cr. 

To loan $45,000 By 500 shares A.T.S.F. 

To interest 225 @ 92 $46,000 

To commission 125 

Balance due Jones 650 

$46,000 $46,000 

2 17 



THE CAREFUL INVESTOR 

You have lost $4,350, perhaps in a single day. 
This is margin speculation. This is what keeps 
the stock exchanges and the brokers' offices going. 

There are two questions to ask about specula- 
tion. First, is this the best way to speculate? and, 
second, what is the chance of profit in speculation? 
A few years ago, in a large Eastern city, there was 
a stock exchange house that was supposed to be 
impregnable. The partners were popular and 
respected. They were closely related to two of the 
wealthiest families in the city. The firm was 
reported to have ample capital. One morning 
this firm closed its doors. Its liabilities were 
enormous. Most of its assets had disappeared. 
No explanations were forthcoming. The creditors 
were called together and informed that, for family 
reasons, relatives of the firm would make up most 
of the shortage, provided there was no prosecution. 
Another house in the same city recently failed. It 
paid to unsectired creditors ten cents on the dollar. 

Cases like these usually involve breaches of 

trust between broker and client. You give the 

broker your money to secure him in borrowing a 

much larger amount of money with which to buy 

500 shares of Atchison stock for you. You leave 

the stock with him as security for your loan. It 

18 



A LAMB IN THE STOCK MARKET 

is your stock. The law says that your broker 
must hold it for you. He can pledge it at the 
bank, but he must pledge it for your benefit, so 
that whenever you want to pay the balance due, 
you can have the stock. If your broker pledges 
this stock for his own benefit, or in any way puts 
it out of his power to deliver you these 500 shares 
when you come for them, the law of New York 
and Pennsylvania says he is guilty of larceny. If 
your broker obeys the law and keeps your securi- 
ties for you, he might, indeed, fail in business. 
His own fimds might be eaten up in speculation 
for his own account, or in expenses, but his failure 
would disclose no "unsecured creditors." No one 
would lose except himself. 

When you deal with a broker on this basis of 
depositing margin, you depend absolutely upon his 
good faith and fear of the law. If he chooses to 
use for his own benefit the stocks which belong to 
you, you cannot stop him, for, as long as he re- 
mains solvent, you will know nothing about the 
matter. There is no inspection of brokerage houses. 
They are all partnerships. There is no bank ex- 
aminer to go over the books. The customers of 
brokerage houses are absolutely at their mercy. 

If a safe method of margin speculation could be 

19 



THE CAREFUL INVESTOR 

suggested, surely no one would deal through the 
broker. Yet such a method is available to any- 
one with a substantial bank account. If you have 
faith in the Atchison; if you believe it is going 
up; if you are not content with the profits on 50 
shares which you have the money to buy and pay 
for; if you want the profits on a large number of 
shares, — go to your banker. Give him your order. 
He will lend you 80 per cent on any Atchison 
stock which you may own, and he wiU buy the 
stock for you through some broker, charging you 
only the broker's commission. You cannot buy 
as many shares through your banker as through a 
broker, but in all other respects the transaction 
to you is the same as though you had dealt through 
the "banker and broker." 

The bank buys the stock for you. You pay the 
bank $5,000. You sign a note for the balance of 
the purchase price. It is your stock. The certifi- 
cate is made out in your name. Your note is 
pinned to the certificate, and it goes along with it. 
The bank does not use your stock for its own 
purposes, for the bank is a pubHc institution, a 
corporation with a regtdar organization. What- 
ever it does must be known to the officers or direc- 
tors. Its accounts are published. It is subject 

20 



A LAMB IN THE STOCK MARKET 

to the inspection of the bank examiners. You 
know that when you buy stock on margin through 
your bank you may lose your money, but your 
loss will be the result of your own bad judgment, 
and not of the larceny of a broker. 

Since, now, as speculators in stocks on margin, 
we have found a safe way to speculate, what are 
our chances of profit? They are poor, very poor, 
almost negligible. Space does not permit at this 
time any extended discussion of the reasons why 
the margin speculator has no chance. Let two 
cases suffice where speculation on the most posi- 
tive information went wrong. 

Many years ago, an Eastern railroad was in 
trouble. It was a large producer of coal, which it 
sold through agents. One firm of agents had posi- 
tive information, which came to them in the 
course of business, that bankruptcy was inevitable. 
They knew it, and subsequent events proved that 
they were right. They resolved to take advantage 
of this knowledge in the stock market. They 
raised $30,000, all the money they could get to- 
gether, and they sold this stock short on a 10 point 
margin. That is to say, they made a contract 
through their brokers with certain other brokers 

to lend them 15,000 shares of this stock, and they 

21 



THE CAREFUL INVESTOR 

agreed to deliver 15,000 shares on demand. This 
stock they sold for $300,000, leaving the $300,- 
000, together with the original $30,000, with the 
broker to secure the transaction. They expected 
that the stock wonld drop to 10. Then they would 
order the broker to buy 15,000 shares, which 
would cost only $150,000; return the shares to the 
brokers from whom they had borrowed them, and 
receive from the brokers the difference between 
$300,000 and $150,000, less the brokers' charges 
as their profit. They woiild also get back their 
original stake of $30,000. 

Now, observe. The information was accurate. 
The railroad company was in a bad way. It did 
fail — Plater. Its stock did drop, not only to 10 but 
to 5 — ^later. At the time, however, certain power- 
ful and wealthy men decided to put the price of 
this stock up, and by heavy buying they did put 
it up to 25. Our friends the coal dealers were 
caught in the rise. Their broker was asked to 
return the 15,000 shares. He bought these shares 
at 22, costing $330,000. The $30,000 was gone. 
The firm failed, and it was no comfort to them 
that the railroad failed soon after. 

One more instance. A prominent attorney was 

employed by certain stockholders to bring suit to 

22 



A LAMB IN THE STOCK MARKET 

dissolve a large company whose stock was active 
on the exchange. The announcement of the suit 
was sure, as he thought, to break the price of the 
stock. So he raised $15,000 and sold the stock 
short. Now, mark, his information was accurate. 
He himself had drawn the papers. He himself was 
to file them. He was to give out the news. The 
news would break the price of the stock at least 
10 points. He was certain to double his money. 
The stock was sold at ten o'clock, immediately 
after the opening of the exchange. At noon, an- 
nouncement was made that this company would 
be merged with others into a large company. The 
suit was withdrawn. Immediately the stock ad- 
vanced. The lawyer was fortunate to escape with 
the loss of half his stake. 

Here are two cases where shrewd and intelligent 
men, "on the inside," possessed of accurate and 
exclusive information, tried to turn their knowl- 
edge into money and failed. Such cases are not 
exceptional. The wisest speculator this country 
ever produced said that he was satisfied to be 
right four times out of seven. The speculator of 
average intelligence and good fortune can be sure 
of one thing : that if he sticks long enough at the 

game, he will lose all he puts in. 

23 



THE CAREFUL INVESTOR 

I do not wish to be understood as saying that 
it is not possible to buy stocks in part with bor- 
rowed money when prices are low, and profit by 
the advance. This is possible, and is not attended 
with serious risks if the purchaser is careful to 
maintain large margins for his loans; if he buys 
dividend-paying stocks, the income on which will 
offset the interest on his loans ; and if he is satis- 
fied to wait. I do not believe that there is much 
risk in the purchase of sound railroad stocks on 
this basis. Eventually — ^it may be after the lapse 
of years, but some day — the purchase will prob- 
ably show a profit. But for the margin specu- 
lator, for the trader who buys and sells on tips 
and rumors, who is in and out of this or that 
stock, against whom 6 per cent, interest is always 
running, and who must pay $25 commission on 
every block of 100 shares, for the great army 
of the "public," the people who pay the brokers' 
bills, who keep the Stock Exchanges running, 
there is a certainty of just one thing: certain 
and total loss. 

A broker once told me that there was one rule 
which he would give, if he dared, to his customers, 
to guide them in selecting stocks for trading pur- 
poses. "Take a piece of chewing gum. Reduce 

24 



A LAMB IN THE STOCK MARKET 

it to an adhesive condition. Mould it into a form 
convenient for throwing. Throw it at the quota- 
tion board. Buy or sell, according to the toss of 
a coin, the stock indicated by the spot on the 
board to which the chewing gum adheres. Go to 
Europe for three months." By following this 
advice, he said, the customer would have a chance 
— not much of a chance, it is true, but some chance. 
If, however, he reads the financial page of the 
newspaper, and listens to the gossip in the brokers' 
offices, he has not even the gambler's chance, since 
he will be doing exactly what the powers back of 
the market want him to do, that they may as 
quickly as possible get his principal before it is 
exhausted by the constant nibbling of the broker. 

A well-to-do man showed his ingenue bride a 
check for $ 1 , 800. * ' Do you see this check ? Now, 
with this I'm going to buy sugar. Sugar is going 
up, and I'll give you the profits." Sugar went 
down, and he lost his $1,800. The lady asked for 
an accoimting. "My dear, sugar went down. 
The money is lost." "And you haven't any sugar," 
she asked plaintively, "not even any sugar?" 

It will be well for the American people if the 

present dullness in brokerage circles, in so far as 

this dullness represents increasing knowledge of 

25 



THE CAREFUL INVESTOR 

the pitfalls of margin speculation, shall continue. 
For money making, margin speculation is worth- 
less. As a means to loss and ruin, it has no rivals. 

So much for the traders. What now of the 
brokers? Do they make money, and how much 
do they make? 

A stock brokerage business is profitable imder 
ordinary conditions if the broker does not trade for 
his own account. On a certain mildly active day 
on the Philadelphia Exchange — a very small affair 
compared with the New York Exchange — a broker 
told me that his commissions amounted to $750 
on that day's business, and his business is not of 
the first rank, even for Philadelphia. If only the 
broker will keep out of the market for his own 
account, and confine himself to working for his 
"clients," he is pretty sure to succeed. 

Providing the necessary police arrangements 
can be made, all branches of the gambling busi- 
ness, from stuss to faro, are extraordinarily prof- 
itable. Even if the games are honestly conducted, 
providing only that the house has ample capital, 
the returns are more certain than in any other 
branch of pecimiary activity. But when the 
keeper of the gambling house ttims gambler, the 

testimony is imanimous that he is sure to lose. 

26 



A LAMB IN THE STOCK MARKET 

So in the stock market game, in which more 
gambling is done than in all other games of chance 
combined, the people who make money are those 
who keep the game, who take their percentage in 
commissions and interest on every transaction. 
The players in this game, as in every other game 
of chance, are sure to lose. Surely if the men who 
live in daily contact with the security market can- 
not make money out of operations in stocks, the 
outsider has even less chance of profit. 

But what of the study of "fundamental condi- 
tions " ? If we study crops, earnings, interest rates, 
etc., can we not make money in stock speculation? 
Is it not a fact that brokers are too close to the 
market to take proper account of its underlying 
tendencies? Is not the stock market far different 
from the roulette table ? Can we not predict from 
a study, say, of Reading or United States Steel, 
the future course of these stocks, and make money 
by following our conclusions with our money? 

Some years ago a wealthy New York merchant 
retired from business. His fortune ran into seven 
figures. He was well educated, well informed, 
studious. He enjoyed a wide acquaintance among 
bankers and business men. He himself was a 
director in several banks, and in a position to 

27 



THE CAREFUL INVESTOR 

hear the latest and most acoirate information 
affecting security values. He decided, for the 
remainder of his active life, to occupy his mind in 
operations in stocks. He applied to this business 
the same care and attention that had brought him 
his fortime. He was very conservative. He 
bought only after a careful study of imderlying 
business conditions, as well as of the circumstances 
of the particular companies in which he was inter- 
ested. He had ample capital to follow his opera- 
tions to a conclusion. For seven years he dealt in 
stocks. In that time his purchases and sales totaled 
over $12,000,000, and showed a profit of less than 
$1,000 as the reward for large capital and a first- 
class business man in stock speculation. 

My belief, based on a somewhat extended ob- 
servation of the work which students of funda- 
mental conditions are doing, is that what I have 
described as the "chewing gum" method of specu7 
lation is, in the long nm, about as safe as specula- 
tion based on a study of "imderlying conditions." 

Especially is the studious speculator urged to do 

his own studying and to avoid the professional 

stock-market educators. Every one knows who 

they are. I am acquainted with several of them 

who are doing very well indeed in selling predic- 

28 



A LAMB IN THE STOCK MARKET 

tions based on "a study of fundamental condi- 
tions" to persons who are willing to pay a good 
price each month for the "service." For thirty 
dollars a month, you can have daily converse 
with one of these schoolmasters who will tell you 
when and what to buy and sell. It makes little 
difference in the final result. You will perhaps lose 
your money in less time, and the broker will get less 
of it by the amoimt you pay for education. Some 
of these students have lost a great deal of money 
by taking the advice which they sold to others. 

I do not believe that any man, or any committee 
or congregation of men, no matter how well in- 
formed, can safely advise the purchase or sale on 
margin of speculative securities. Accurate pre- 
dictions in this field are very difficult. Prices are 
"made," to a large extent, on the stock exchanges. 
Ask your broker, if you can find him in a confiden- 
tial mood, whether he ever "matches" orders. 
Of course he does. When a pool is formed to 
raise the price of a stock, orders are distributed 
both to buy and to sell. The members are dealing, 
through brokers, with one another. They mark 
up the quotations, hoping to attract a public fol- 
lowing, who will take the stocks they have accu- 
mulated off their hands at a profit. Sometimes 

29 



THE CAREFUL INVESTOR 

the instructions are misiinderstood, and the game 
is given away by a jump of thirty points in Rock 
Island in half an hour. In that case, the broker 
who had the selling order was snowboimd, or sick, or 
otherwise unavailable, and when the buying order 
was executed, there was no stock for sale. The 
Stock Exchange severely disciplined the offenders. 

While the pool is working, the newspaper men 
are fed with news calculated to help along the 
movement. Rumors that "Frick is buying into 
the company," or that "the Erie will purchase 
the road," or that "a conflict for control of the 
company is in progress," are passed out, and some- 
times printed, although it is not so easy as it once 
was to fool the financial editor. If the pubHc is 
attracted and buys the stocks, the pool may 
change to the bear side and sell short. Then 
another set of rumors is set afloat. "There is 
friction in the Union Pacific Board," "The Harri- 
man estate is selling out its stock," etc., etc. The 
president of a large Western railroad recently said 
that the only trouble with the stock of his com- 
pany was the "lie factory in Wall Street." 

I do not wish to be misimderstood. Stocks do 
rise and fall from certain ftmdamental causes. 
A crop failure, for example, ought to produce a 

30 



A LAMB IN THE STOCK MARKET 

decline in the stocks of railroads located in the 
region affected. But suppose that the crop failure 
comes during a boom year, when business all over 
the country is expanding; or that a failure in the 
wheat and com traffic is offset by a rapid growth 
in oil and coal ; or that the company has been very 
conservative in the management of its income, 
has paid out in dividends only half its earnings, 
and now makes a special distribution to its stock- 
holders. In such case, crop failure might be more 
than neutralized by the favorable influences, and 
the "scientific" speculator who had sold "short'* 
because, after a careful study of rain-fall statis- 
tics, he had reached the correct conclusion that 
there would be a short crop in the south-west and 
a reduction in railroad earnings, might lose his 
entire stake, in spite of correct reasoning. 

Is there no safe method of speculating on margin ? 
Cannot a man with $5,000, for example, employ 
this to control $50,000 of stock, so that if the 
price of this stock advances ten points, he can 
double his money ? I know of two methods which 
are relatively free from danger, and since I have 
said so much against margin speculation, these 
methods ought to be explained. 

In recent years many railroads and a few indus- 
31 



THE CAREFUL INVESTOR 

trial corporations have been issuing a security- 
known as a ' ' convertible debenture. ' ' A debenture 
bond is a promise of a corporation to pay the bearer 
or registered owner $i,ooo in, say, 1943. Suppose 
the company has $5,000,000 of these debentures 
outstanding, on which it pays five per cent, inter- 
est, or $250,000 a year. The company's profits 
available for interest payments may be $1,000,000 
a year. In such a case the debentures would be 
good. They would usually sell between 90 and 
100 per cent, of the par value, sometimes rising to 
100 and sometimes falling to 90. 

Now, suppose that this company, needing addi- 
tional funds, decides to issue $10,000,000 of deben- 
tures in place of this $5,000,000, providing $5,000,- 
000 of cash and retiring the old issue by exchange. 
In order to make the new bonds attractive, they 
are made convertible into stock at par. That is 
to say, any holder of a $1,000 debenture bond can 
at any time exchange it for ten shares of stock. 

Now observe what happens. If the company 

prospers, and raises the rate of dividend on its 

stock from 6 per cent, to 12 per cent., the stock 

may advance from, say, 90 to 175. Since the 

debenture bonds can be exchanged at par for the 

stock, and since one bond equals five shares of 

32 



A LAMB IN THE STOCK MARKET 

stock, the value of the debentures will follow up- 
ward the value of the stock for which they can be 
exchanged. So much for the profit side of the 
speculation. Any one holding the bond will see 
it rise in value as the stock rises. 

But, as we have seen, there is a loss side to 
speculation, a side nearly always in evidence. And 
it is these losses which speculation, through the 
purchase of convertible debentures, will reduce to 
a minimum. In the case just cited, suppose net 
earnings fall 50 per cent., due to an industrial 
depression. The price of the stock purchased at 
90, when a 6 per cent, dividend was paid, might 
fall to 45, when the payment of dividends, owing 
to reduced earnings, was suspended. Suppose now 
that, with $5,000 cash, our speculator had pur- 
chased 550 shares on a 10 per cent, margin. In 
the decline, if he held on and did not sell, his 
$5,000 would soon be gone. But if he had bought 
on the same margin 50 convertible debenture 
bonds at 100, he might have a chance. 

For these debentures come ahead of the stock. 

Their interest must be paid before any dividends 

are paid. A decline in earnings which might make 

it necessary to pass a dividend need not affect the 

security of these debentures. They might not 
3 33 



THE CAREFUL INVESTOR 

fall below 92. The speculator who held them 
might have to raise another $2,500 of margin. 
He might be forced to sell a part of his holdings 
to get the necessary margin to protect the re- 
mainder, but his loss need not be total. So long 
as interest on the debentures is earned, the fear 
of bankruptcy to follow the non-payment of 
interest will constrain the directors to protect the 
bonds. So the price of the debentures, as I have 
said, will not get down to 90, although the stock 
might fall to 45 or even lower. 

Another method may be suggested whereby the 
spice of speculation may be injected into the 
nourishing but less appetizing dish of investment. 
This is the instalment plan of purchasing stocks. 
By this method, assuming that in three years you 
can save $15,000, and that you consider a certain 
stock, Erie 2d preferred, for example, an attractive 
purchase at 40. You believe, from study or advice, 
that within three years Erie 2d preferred will go 
to $70 per share. You want to profit by your 
conviction, to make the largest possible profit con- 
sistent with safety. You want to invest in Erie 
2d preferred on margin, but you do not want to 
risk the loss of your capital. Assume that you 

have $1,500 to start with, and that you can save 

34 



A LAMB IN THE STOCK MARKET 

$13,500 more in three years, at the rate of $375 a 
month. You make a contract with your broker 
to buy 375 shares of Erie 2d preferred at $40 a 
share, $1,500 down, and $375 a month for 36 
months. When the broker makes this contract 
with you, you are safe against being sold out, so 
long as you keep your agreement. Erie 2d pre- 
ferred may drop to 30 the day after the contract is 
signed, but the broker must hold the stock for you 
and deliver it to you when you pay $13,500, either 
in the instalments stipulated or in larger sums. 

Now suppose the Goddess of Chance, not being 
able to get at you, sheltered behind your instal- 
ment contract, to do you harm, turns propitious 
and Erie goes up to 50 the month after your con- 
tract is signed. You have more than doubled 
your money, for you can sell yotir 375 shares for 
$18,750, pay your broker the $13,500 you owe 
him, plus commission and interest, and have about 
$3,500 in place of your original $1,500. If this 
method is applied to the purchase of dividend- 
paying stocks which will produce an income to 
offset the interest, stocks which have a solid basis 
in assets and earnings, and which you would be 
glad to hold as permanent investments, there is 

no valid criticism to be made against it. 

35 



II 

STOCKS OR BONDS 

We turn now from the subject of speculation, 
the purchase or sale of securities to make a profit 
from their rise or fall, to the subject of investment, 
the purchase of securities to receive the interest 
or dividends which they pay, and the first question 
which we encounter is the choice of securities. 
Shall the investor buy stocks or bonds ? 

"Give me a seat in the front row," said an 
investor to his banker. *'No stock, no real estate, 
no equities, for me. I do not want to look over 
the shoiilders of the audience. I want the front 
row. Put my money into bonds." 

This is the richest nation in the world, and, next 
to France, the most thrifty. In a normal year the 
net income of the American people, after paying 
most liberal living expenses, is far in excess of their 
operating expenses . An enormous amoimt remains 
for investment. What becomes of this money? A 
large amount of this money is put into savings 
banks. A large amotmt goes into insurance. A 

36 



STOCKS OR BONDS 

still larger sum is put into enterprises of various 
kinds which have stock for sale. Some goes into 
real estate, and a constantly increasing fraction 
into bonds. 

It has been estimated that on the average a 
quarter of a billion dollars a year, and the real 
figures are probably higher, is lost in bad invest- 
ments; sunk in margins on the stock exchange; 
donated to the brood of mining and industrial 
schemes whose promises are gold, and whose per- 
formances are chaff and stubble ; invested in town 
lots in some ''thriving industrial suburb " ; or even 
used to purchase on margin standard railway and 
industrial stocks, which seem to advance only 
long enough to inflict heavy losses upon those who 
purchase them for still further gains. These are 
the vast losses in the game of business hazard, 
where the dice are always loaded and the cards 
are always marked. 

On the other hand are the timid ones, who buy 

the obligations of the government, who put their 

money into savings banks or into life insurance, 

whose most daring flights are the ptirchases of the 

homes in which they live. These are recruited 

either from the anaemic or the dyspeptic, or from 

the burnt children who, as a result of sad experi- 

37 



THE CAREFUL INVESTOR 

ence, dread the fire. Between these two classes 
are the institutional buyers of bonds; the insur- 
ance companies; savings and commercial banks, 
who purchase as trustees for their policy-holders 
and depositors, taking a liberal toll for their ser- 
vice ; and the individual bond-buyer, the man who 
is intelligent enough to buy his investments at 
first hand, and, at the same time, sufficiently con- 
servative to decHne to participate in the risks of 
business. 

"What is a bond? How does it differ from a 
share of stock? Why does it offer a safer place 
for my savings than a savings bank or a trust 
company, while at the same time allowing me a 
moderate share in the profits of business?" These 
are questions often heard, but seldom clearly 
answered. 

A bond is a promissory note, a contract to pay 
money, executed and issued by a corporation, 
either public or engaged in private business, and 
bearing interest at 4, 5, or 6 per cent., according 
to the location of the borrowing company or the 
business in which the corporation is engaged. The 
payment of this promissory note is usually secured, 
principal and interest, by a second agreement, 
executed between the borrowing company and a 

38 



STOCKS OR BONDS 

trustee for the lender, usually a trust company, 
by which the property of the buyer is transferred 
to the trustee, in trust, to secure the punctual per- 
formance by the corporation of all its agreements, 
including not merely the payment of interest and 
of principal when the note matures, but the keep- 
ing of the property in good repair, and the per- 
formance of many other covenants which increase 
the safety of the loan. The corporation bond is, 
therefore, not only protected like any other prom- 
issory note by all the property of the borrower 
which can be sold for the lender's benefit if default 
is made on either interest or principal, but it is 
safer than an unsecured promissory note in that 
the property of the borrower is formally set aside 
as security for the loan. The borrowing company 
can neither sell the property nor place any addi- 
tional incumbrance upon it, nor increase the 
amount of its indebtedness secured by existing 
incumbrances, without the consent of every bond- 
holder, which is, of course, seldom given. 

And this is not all. If only the bonds of ' ' going 
concerns" are purchased — that is, the bonds of 
corporations doing a profitable and increasingly 
prosperous business — the security of the investor 

whose bonds are protected by a first lien on all 

39 



THE CAREFUL INVESTOR 

the property of the corporation, is not merely the 
property which is purchased with the money which 
he pays for his bonds, and which he is safe in sup- 
posing will earn more than enough to pay his 
interest, but, in addition, all the previously exist- 
ing property of the company. In other words, if 
the investor exercises that degree of care in the 
selection of his bonds which any prudent man will 
naturally give to the conduct of affairs in which 
he is interested, both his principal and his interest 
are secured and secure. 

Now contrast the position of the corporation 
bond-holder, the creditor of the company, with 
the position of the stock-holder. A share of stock 
is a certificate of part ownership in a corporation. 
A corporation is an association of persons to which 
the law gives the right, after certain simple for- 
malities have been complied with, to own property, 
and to carry on certain kinds of business. It is 
the association which owns the property, which 
borrows, buys, and sells. The association issues 
stock which represents its ownership, in exchange 
for money or property. 

This stock is divided into shares. It comes into 
possession of those who expect through its means 
to share in the profits of the company. The stock- 

40 



STOCKS OR BONDS 

holder is the owner of the corporation, as the cor- 
poration is the owner of the property. The stock- 
holder does not own any part of the factory, or 
mine, or railroad. He owns a part of the company, 
and the company owns the property. 

As the stock-holder does not own the property 
of his company, so he does not manage the com- 
pany's business. That is done for him by trustees 
called directors, whom the law makes him elect. 
Each share of stock counts as one vote at the elec- 
tion, and a majority of the stock can elect the 
entire board. For example, a corporation capi- 
taHzed at $10,000,000 may have 100,000 shares of 
stock. An investor has purchased 100 shares. At 
the election he has 100 votes out of 100,000, or 
one thousandth part of the total. So the "right 
to vote," which is one of the privileges of the 
stock-holder, not enjoyed by the bond-holder, 
amounts to little. 

The small stock-holders in the best managed, 
largest, and soundest American corporations, either 
singly or in combination, have, practically speak- 
ing, no influence upon the election of directors. 
Where the officers care to take the trouble they may 
send out proxies, blank powers of attorney for 

stock-holders to sign, but in only the most excep- 

41 



THE CAREFUL INVESTOR 

tional cases can an individual stock-holder, who has, 
in theory, the same right to solicit proxies as the offi- 
cers, gain sufficient support to influence the election. 

So well is this powerlessness of the stock-holder 
recognized, that some of the largest railway sys- 
tems in the United States are dominated down to 
the last director and the last official by men who 
own only a few shares of stock, but who, in case of 
need, can secure by sending out requests for 
proxies, the cooperation of a sufficient number of 
stock-holders to enable them to control a disputed 
election. The late Henry 0. Havemeyer, who was 
in absolute control of the American Sugar Refin- 
ing Company to the day of his death, held about 
2/100 of one per cent, of its stock when he passed 
away. Elections are seldom disputed. Stock-holders 
are too widely scattered and too apathetic to 
take much interest in the way their company's 
affairs are conducted. While they receive divi- 
dends, they are content, and when dividends are 
reduced or suspended, their dissatisfaction seldom 
rises above sleepy growls of irritation and disgust. 

The stock-holder also has the right to partici- 
pate in profits, when, and only when, these are 
distributed by the Board of Directors. If the 
profits are not earned, he receives no dividends. 

42 



STOCKS OR BONDS 

Even when large profits have been earned, he 
cannot obtain any share in them, unless the direc- 
tors declare a dividend, and there is no power to 
force the directors to take such action. They can 
decide to pile up profits, and the stock-holders, 
unless they are able to put the directors out, which 
seldom happens, are helpless to interfere. They 
own shares in the company, it is true, but often 
this does them little good. 

Of course, there is a brighter side to the picture. 
Sometimes profits are very large, and the stock- 
holder gets large dividends, but he must always 
bear in mind that the bond-holder's interest must 
first be paid, and that any losses which the com- 
pany may sustain must first fall upon its owners. 
And how numerous those losses are! Within a 
few months in 1908, the United States plunged 
from prosperity into depression, and down went 
the dividends of many of the strongest railroads 
and industries ; some of them suspended altogether, 
others seriously reduced. 

The stock-holder has no assurance, moreover, 

that the amount of stock outstanding will remain 

where it is. He may be called upon to authorize a 

doubHng of the capital stock, raising the number of 

shares from 100,000 to 200,000. The new stock 

43 



THE CAREFUL INVESTOR 

may be issued for property or for money, and the 
investment may be profitable, but there are now 
twice as many shares, and the universal practice 
of increasing stock capital keeps down the dividend 
rates of even the most prosperous companies to 
6 or 7 per cent. 

It is a hard saying, but a true one, that the 
small stock-holder in American business corpora- 
tions has no influence in selecting the directors, 
no voice in the management, and but little power 
to protect himself against the directors should 
they decide to keep him out of his profits for the 
purpose of depressing the value of his holdings, 
so that they may purchase it from him at low 
figures, or practice upon him simdry other arts 
of the stock manipulator. He is powerless to pre- 
vent an imlimited increase in the amoim.t of stock, 
if made for lawful purposes and in a lawful manner. 
He has no claim upon the company to pay him 
dividends, and if he is dissatisfied with the way 
his business is conducted, his only remedy, in the 
language of a famous legal decision, is either "to 
elect new directors" — a manifest impossibility for 
the small investor — or '*to sell his stock and with- 
draw," which he frequently does at a considerable 

discoimt from the price he paid. 

44 



STOCKS OR BONDS 

How different and how vastly superior is the 
position of the investor who has purchased from 
reputable and responsible bankers the mortgage 
bonds of the same enterprises whose stock-holders 
are liable to so many hardships and mishaps. In 
common with the stock-buyer, the bond-buyer 
contributes money to construct and extend the 
plant of the corporation. They are both inter- 
ested in its property and its profits. But here the 
resemblance between the position of the two in- 
vestors abruptly ends. The bond-holder must be 
paid his interest regtdarly or the company becomes 
a bankrupt. The stock-holder's dividends need 
not be paid at all, unless the directors so decide, 
and they may be lowered or raised at the directors* 
pleasure. There is no certainty about them. 

The bond-holder knows that his money has 

gone into some kind of property — ^his trustee sees 

to that. The stock of the same company may have 

been originally issued for the *' good- will'' — often 

the *'good will" of those who receive the stock. 

The money which he pays very often goes not to 

the company, but to its promoters, and those who 

have sold property to it. The money which is 

paid for stock takes the forms, not of rails, ties, 

and power-houses, but of automobiles, horses and 

45 



THE CAREFUL INVESTOR 

yachts. The bond-holder does not own any part 
of the corporation, as does the stock-holder, but, 
on the other hand, the stock-holder does not con- 
trol any part of the property, while all the prop- 
erty is conveyed to a trustee for the safeguarding 
of the bond-holder's interests. The bond-holder 
knows how much of a particular issue he owns, and 
he knows that the total amount of this debt may 
not be increased unless he gives his consent. 
Before the stock-holder, on the other hand, 
stretches an endless vista of new issues, whose 
amount he is powerless to regulate or limit. 

The bond-holder has a first claim upon earnings. 
In very few cases will they ever fall so far as to 
endanger his interest. Even in those cases where 
bonds of inferior security, or which have been 
issued in excessive amounts, are purchased with- 
out proper investigation, from bankers who valued 
immediate profits above the permanent confidence 
of satisfied customers — and most of these bankers 
belong to a past generation — and when these bonds 
have been in default, the investor has seldom sxif- 
fered any permanent damage if he has held on to 
his security. These companies have been reorgan- 
ized; new bonds or preferred stock are issued for 

the bonds in default; and, in the great majority 

46 



STOCKS OR BONDS 

of cases, all the losses have been regained, some- 
times with a large profit. The stock-holder, on 
the other hand, takes what is left after interest 
is paid, be that remainder much or little. He 
comes after the bond-holder. He sits in the lowest 
room, eats at the second table, occupies a seat in 
the back row. Long before the bond-holder*s 
interest is reached by the decline in earnings, the 
stock-holder's dividends are suspended, and the 
reorganization which passes lightly over the credi- 
tors falls upon the owners with crushing force. 

As a final difference between stock and bonds, 
the value of a first mortgage bond, because of all 
the advantages and points of superiority which 
have been mentioned, changes very little in com- 
parison with the value of the stock of the same 
company. The stocks of even the safest and best 
managed companies show the most astonishing 
gyrations, the wildest fluctuations. They fall 
$io, $20, $30, $50, a share, within a few months, 
while the bonds, securely protected by their posi- 
tion as first and fixed claimants to income, rise 
and fall very slowly and within very narrow limits. 
The owner can usually be certain of realizing on 
his investment with but trifling loss. What the 

stock-holder will get may depend on the honesty 

47 



THE CAREFUL INVESTOR 

of some New York bank president, the digestion 
of a high government officer or the success of the 
advertising campaign of some stock-manipiilator. 
Whether to sell or to pledge as security for loans, 
bonds are conspicuously better than stocks. 

Now, then, if bonds are so much better than 
stocks, that the wayfaring man, if not altogether 
a fool, cannot fail to appreciate their superiority, 
how shall bonds be bought? Shall the investor 
turn his money over to an insurance company in 
an "endowment" policy, or to a savings bank or 
trust company, or shall he buy bonds direct ? The 
answer is not difficult. It is his money which 
buys the bonds in any event, whether he deposits 
it in a bank or pays it as premiums to an insur- 
ance company, or whether he chooses the better 
plan, and himself buys the same bonds which 
these institutions piirchase with the money which 
he contributes. 

Why should he not buy direct and obtain the 
higher interest of direct ownership? There is 
only one objection to direct bond-buying, the 
lack of the ability, or rather the lack of experience, 
of the private investor to select soimd investments. 
There are all sorts of bonds, good, bad, and indif- 
ferently poor. Great care and much intelligent 

48 



STOCKS OR BONDS 

investigation is required to choose good bonds for 
investment. The insurance companies and the 
savings banks pay high salaries to experienced 
men to make investments for these institutions. 
Their depositors and policy-holders reap the bene- 
fit in perfect security, to obtain which they sacri- 
fice a part of the money which is earned on the 
investment of their money by these institutions. 
The investor does not possess this ability. Left 
to himself in his bond-buying, he may go badly 
astray. Nor can he afford to pay adequate fees 
to expert advisers. 

Into this situation comes the bond-house, with 
its organization of experienced investigators, far 
superior to those employed by the insurance com- 
pany or savings bank, its large capital and still 
larger credit. The bond-house buys the bonds of 
enterprises in which it has confidence with its own 
money, purchasing them not as a broker or agent, 
but as an investor, and then resells them at a 
small profit to private investors, who are in this 
way able to purchase, with perfect security in 
both interest and principal, bonds which pay them 
much higher returns than they can receive from 
any institution to which they may entrust their 

savings. 

4 49 



Ill 

THE CORPORATION MORTGAGE AND 
THE DEED OF TRUST 

Most people who have saved money are ac- 
quainted with the nattire of a mortgage. They 
understand it as a lien upon property, given to 
secure a debt. The conditions of the lien are that, 
in case the debt is not paid at maturity, the lender 
who holds the lien can force a sale of the property 
by judicial process, having his own debt paid out 
of the proceeds, and returning any balance to the 
borrower. 

While the operation and effect of the real-estate 
mortgage are generally familiar, the nature of the 
lien conferred by the mortgage is not equally well 
imderstood. A mortgage is a conveyance of prop- 
erty by the owner to the lender. It is in form and 
in effect a deed similar to the ordinary deed by 
which property is conveyed from one person to 
another. The conveyance is, however, coupled 
with the condition that the creditor holds the title 
to the property, as trustee for the owner. The 

conditions of the trust are as follows. If the debt 

50 



THE CORPORATION MORTGAGE 

to secure which the conveyance is made is not 
paid at maturity, or if any other covenant in the 
mortgage is broken by the lender, the trust, which 
up to that time has been a "passive " trust, becomes 
active, and the lender, known as the mortgagee, 
asserts his title to the property and forces its sale. 
The agreement between the parties binds the 
borrower, the owner of the property, not only to 
the payment of interest and principal, but also 
to the performance of certain other covenants of 
great importance to the security of the debt. For 
example, the owner must insure the property and 
make the policies payable to the lender; he must 
also pay the taxes and deliver the tax receipts to 
the holder of the mortgage, since a failiu-e to pay 
taxes might result in a sale of the property by the 
State, which would deprive the lender of his 
security. The borrower agrees to keep the prop- 
erty in good repair. He further agrees not to sell 
any portion of the mortgaged property without 
the consent of the lender, who will, of coxirse, not 
allow such a sale to be made unless the proceeds 
are applied either to the liquidation of the debt 
or to the piu-chase of new property of equal value 
to that sold. 

This mortgage or conditional deed which con- 
51 



THE CAREFUL INVESTOR 

veys the title to real property to the lender is given 
to sectire a debt in the form of a bond. This bond 
is a simple promise to pay a definite sum of money, 
with interest, at a certain date in the future. It 
is signed by the owner of the property. The real- 
estate mortgage therefore comprises two contracts : 
first, a contract to pay money, and, second, a con- 
veyance of real estate to secure the fulfilment of 
a contract to pay money. 

When the conveyance, otherwise known as the 
mortgage, is copied into a book of record kept in 
a public ofiice for the inspection of all those who 
may be interested, it fixes the title of the mortgage- 
holder as against all the world. The owner of the 
property, who is left in possession so long as he 
carries out his agreements with the lender, is free 
to sell his interest in the property. He must sell 
it, however, subject to the right of the lender to 
enforce the provisions of his contract. It is im- 
possible, in any other way than by a tax sale, to 
separate the interest of the lender from the prop- 
erty to which that interest attaches. 

We have these principles carried out in the 
corporation mortgage bond, the universal form of 
safe investment. There is, first, a promise to pay 
$1,000,000, $5,000,000, or $100,000,000 in ten, 

52 



THE CORPORATION MORTGAGE 

twenty, or fifty years from date. This promise to 
pay, executed by the officers of the corporation, 
is not expressed in the form of a single note, but 
is divided into i,ooo, 10,000, or 100,000 notes, 
numbered serialty from one to the total number, 
and all identical in form, with the single difference 
in the numbers. This division of the corporate 
debt into "pieces" is for purposes of convenience 
in marketing. It is unusual for one investor to 
take more than a small portion of a large loan. 
By dividing a large debt into a number of identical 
notes, each of small denomination, it is possible 
for the company to make a wide distribution of 
its bonds and gather funds from a great number of 
private investors and institutions. 

Just as the corporation bond differs but slightly 
from the bonds executed in connection with the 
real-estate mortgage, so the corporation mortgage 
is practically identical with the more familiar real- 
estate mortgage. Because the creditors of the cor- 
poration are ntimerous, it is impossible to make 
the conveyance to the lenders — there are too many 
lenders. It is necessary, therefore, that a trustee 
should be appointed to act for the lenders, and to 
hold the property in trust for the securing of these 

various obligations. Sometimes an individual trus- 

53 



THE CAREFUL INVESTOR 

tee is named for this ptirpose. The usual practice, 
however, is to designate a trust company, which, 
because of its large capital, and its administrative 
organization experienced in the conduct of matters 
of this kind, makes a more satisfactory trustee than 
an individual. A corporation mortgage is, there- 
fore, usually known as a deed of trust, or sometimes 
as a mortgage deed of trust. 

The form of the corporation deed of trust 
follows the usual outline of real-estate mortgages. 
There is first a description of the bond to secure 
which the mortgage is executed. Then comes the 
detailed description of the property. This prop- 
erty is next conveyed to the trustee in a form of 
which the following is a type : 

NOW, THEREFORE, THIS INDENTURE WITNESS- 
ETH that, for and in consideration of the premises and of the 
acceptance of the refunding bonds by the holders thereof, and 
of the sum of one himdred dollars, lawful money of the United 
States of America, to it diily paid by the Trustee at or before the 
ensealing and delivery of these presents, the receipt whereof is 
hereby acknowledged, and for other good and valuable considera- 
tions, Rogers-Brown Iron Company has granted, bargained, sold, 
aliened, remised, released, conveyed, confirmed, assigned, trans- 
ferred and set over, and by these presents does grant, bargain, 
sell, alien, remise, release, convey, confirm, assign, transfer and 
set over irnto the Trustee, its successors in the trust and its and 
their assigns, forever, all and singular the following described or 
mentioned property, rights and franchises, which collectively are 
hereinafter generally called the trust estate, to wit: 

54 



THE CORPORATION MORTGAGE 

Then follows a detailed description of the prop- 
erty, the same description that is contained in the 
original deeds by which the borrowing and pledging 
corporation took title to the various properties 
named in the mortgage. 

The nature of the conveyance is, however, not 
absolute, but conditional. This appears in the 
following clause ; respectively called the Habendum 
Clause and the Grant in Trust: 

TO HAVE AND TO HOLD all and singular the said prop- 
erty, rights and franchises unto the Trustee, its successors in the 
trust and its and their assigns, forever: — 

IN TRUST, NEVERTHELESS, for the equal and propor- 
tionate benefit and security of all holders and registered owners 
of refunding bonds and coupons and, ... for the enforce- 
ment of the payment of the principal . . . and interest of 
all such bonds when payable, according to the tenor, purport and 
effect of such bonds and coupons, and to secure the performance 
and observance of and compliance with the covenants and condi- 
tions of this indenture, without preference, priority, or distinction 
as to lien or otherwise of one bond over any other bond by reason 
of priority in the issue, sale or negotiation thereof . . . and 
so that the principal, premium and interest of every such bond 
shall, subject to the terms hereof, be equally and proportionately 
secured hereby as if all had been duly issued, secured, and nego- 
tiated simultaneously with the execution and delivery hereof. 

Up to this point, there is no substantial differ- 
ence to be observed between the wording of the 
real-estate mortgage and the wording of the cor- 
porate mortgage. The only points of variance of 

55 



THE CAREFUL INVESTOR 

the corporation mortgage are the greater complex- 
ity, and the fact that in the corporation mortgage 
the conveyance is not to the lender direct, but to 
the lender's representative. 

From this point, however, the corporate mort- 
gage differs from the real-estate mortgage in that 
it contains a variety of covenants entered into by 
the company which owns the property, with the 
trustee who holds the property in trust for the 
security of the debt. These covenants are calcu- 
lated to maintain the value of the security. 

In addition to a repetition of the agreements 
contained in the bond to pay principal and interest, 
the company which owns the property agrees with 
the trustee in the mortgage that it will pay the 
taxes ; that it will pay all claims for labor and ma- 
terials out of which mechanic's liens might arise, 
which might precede the claim of the trustee to the 
property; that the company will maintain the 
property in good condition and repair, and will 
continue to operate the property in the conduct 
of the business to which it is specifically devoted, 
as, for example, the production of pig iron or 
the business of transportation ; that any property 
which they may thereafter acquire, they will, by 

supplementary deeds, convey to the trustee as ad- 

5Q 



THE CORPORATION MORTGAGE 

ditional security to that already conveyed; that 
they will not, without the consent of the trustee, 
sell any portion of the property, and that this 
consent will be given only on condition that the 
proceeds of the sale represent a fair price for 
the property disposed of, and that these pro- 
ceeds are invested in new property to take the 
place of that withdrawn; that the company will 
keep all property subject to the danger of fire 
damage fully insured, and that, if the trustee 
desires, the policies of insurance shall be made 
payable to the order of the trustee, so that the 
money will come into his hands, in order that he 
may superintend its disbursement; that, in so far 
as the company operates any franchises granted 
by municipalities, the obligations of these fran- 
chises will be faithftdly observed; that, in so far 
as it holds any property imder lease, it will faith- 
ftdly carry out the covenants of these leases ; and, 
in general, that the company executing the mort- 
gage and owning the property will carefully 
conserve and protect the physical condition and 
the value of the business as a going concern, so 
that the bond-holders may have at all times ade- 
quate security for their debt. 

The mortgage also prescribes the method of 

57 



THE CAREFUL INVESTOR 

enforcing the rights of the bond-holders in case of 
default in principal or interest, or the breach of 
any other covenant in the mortgage. In such an 
event, the trustee is sometimes authorized to 
seize the property and operate it for the benefit 
of the bond-holders, or, failing in this, to proceed 
in the manner prescribed by law to have the 
property sold and the proceeds of the sale applied 
to the liquidation of the debt. This mortgage is 
then recorded in the coimty seat of every coimty 
in which the property covered by the mortgage 
may be located. From the date of recording 
imtil every covenant in the mortgage has been 
discharged, the bonds of the company are pro- 
tected by a lien upon the property from which 
this property can in no way be released. 

It has been noted that the lien of the mortgage 
has been treated as a lien upon property. In the 
case of a mortgage given by a business corpora- 
tion, the seciirity is, however, far more than the 
physical property. This physical property is op- 
erated by a business organization which often 
represents the result of many years' careful work 
on the part of the owners, and which has reached 
a high degree of efficiency. Connected with the 

property is also a certain amotmt of prestige and 

58 



THE CORPORATION MORTGAGE 

good-will, a business reputation which brings 
trade and increases profits. All of these assets — 
physical property, business organization, good- 
will — together represent the earning power of the 
company, its ability to produce a profit. In these 
profits, not only because the company has prom- 
ised to pay him money, but because that promise 
to pay is backed up by a conveyance of all the 
physical property of the company, the bond- 
holder, after the claim of the State for taxes, has 
the first right to share. 

The mortgage bond-holder is more than a 
creditor of the company. His rights do not depend 
merely upon his ability to sue the company in 
case of default in principal or interest, and collect 
from it by the ordinary process of law. This 
right to sue and collect is a valuable one, but the 
mortgage bond-holder can go much further than 
this. He is also an owner, through his trustee, of 
the property of the company. He has an interest 
in that property. Although that interest is held 
in trust for him, yet should need arise, the powers 
of the trust can be asserted, and the property can 
be seized and sold for his benefit. 

It is this feature of ownership which so sharply 

distinguishes the position of the stock-holder from 

59 



THE CAREFUL INVESTOR 

that of the mortgage bond-holder. The stock- 
holder has merely an interest in the company. He 
owns no property. He and his fellow stock- 
holders, it is true, own the company, and the com- 
pany owns the property subject to the ownership 
of the bond-holder. This is a very different thing 
from the direct ownership of the property, which 
is enjoyed by the bond-holder. Through his 
trustee, the bond-holder actually owns the prop- 
erty. The claim of the stock-holder for dividends 
is contingent not merely upon these dividends 
being earned, but upon the decision of the directors 
to distribute the earnings to the owners of the 
company. With the bond-holder's rights, however, 
the directors can take no liberties. He bears a 
more direct relation to the trust estate than do 
the stock-holders. They are continued in posses- 
sion only so long as they perform the covenants 
of the mortgage. The bond-holders are the owners 
of the property, and they will assert their title 
through the trustee if the company does not faith- 
fully and regularly pay them their interest. 



IV 

THE BANKING HOUSE AS AN AID TO 
INVESTORS 

The plan followed by the conservative invest- 
ment-banker in offering bonds to his customers is, 
first, to purchase the bonds himself, and thus to 
evidence his faith in their soimdness. The expres- 
sion "We own and offer" is frequently met with 
in bankers' literature. Before purchasing any 
bond from a banking house, the investor should 
be careful to ascertain that the house is not acting 
as the agent or representative of the actual owners. 

The risk which the banker takes is not so great 
as that assumed by his customer, since an enter- 
prise may be entirely sound in its early stages, 
when its bonds are sold to the investor, and may 
be afterwards wrecked by bad management. This 
risk the banker passes on to his customer. The 
customer must rely upon the banker's anxiety to 
maintain the good-will of his business, to protect 
him from purchasing unsound securities. 

Notwithstanding this transference of the risk, 

the banker must assimie it in the first instance, and 

61 



THE CAREFUL INVESTOR 

cases are not lacking where large issues of bonds 
have been purchased with the idea of reselling 
them to the investor, but which, by reason of 
some miscalculation on the banker's part, could 
not be sold at a profit and were left on his hands. 

Before ptirchasing any issue of bonds, therefore, 
the conservative investment -banker will provide 
for a careful investigation of every feature of the 
proposition upon the basis of which the bonds are 
issued. 

The countless disappointments in the develop- 
ment of new enterprises are mainly due to faulty 
investigation as to the possibiHties of the project, 
which leads to wrong conclusions as to the profits 
which will be earned. It is the business of the 
banker to guard against these mistakes. The con- 
sideration of a few typical cases will show how 
serious is the risk of the investor who purchases 
securities the soundness of which has not been 
determined by an exhaustive preliminary inves- 
tigation. 

In the neighborhood of a large Eastern city, 

there is a suburban electric railroad, running out 

about twelve miles from a terminal station at the 

end of a city transportation line, through a nimi- 

ber of fashionable suburban towns, parallelling 

62 



THE BANKING HOUSE 

throughout this entire distance the main line of a 
large and well managed steam-railway company, 
particularly distinguished for the excellence of 
its suburban passenger service. The syndicate 
which promoted this enterprise, and which com- 
pleted it with its own money — ^no securities being 
offered to the public — employed engineers of high 
reputation and soimd attainments to examine into 
the cost and anticipated traffic of the enterprise. 
The line was surveyed, estimates were made of 
the cost of obtaining ground for a right-of-way, 
and arrangements were made to purchase a large 
amoimt of real estate for the development of sub- 
urban towns which would furnish traffic to the line. 
The engineers then addressed themselves to the 
possibilities of traffic for the new line. These 
engineers had obtained their experience in the 
West where the interturban electric railway has 
developed in competition with the steam roads, 
and where experience has shown that the electric 
line will almost invariably draw a certain per- 
centage of the traffic of the steam line, which will 
be attracted by the lower rates and more frequent 
service. The method followed in the West in 
figuring the traffic of a proposed electric line, is 

carefiolly to estimate the traffic of the steam line 

63 



THE CAREFUL INVESTOR 

with which it is to compete, and to take a certain 
percentage of the number of passengers as the share 
of the electric Hne, adding thereto an estimate of 
the new traffic which the electric line will develop. 

In the case imder examination, the engineers 
followed this method. They made a careful com- 
putation of the traffic at each of the stations on 
the line of railroad which their line was to parallel, 
and from this estimate, allowing for a certain 
amount of new business, they computed the 
traffic which would be gained by the suburban 
line. Their estimates were accepted by the syndi- 
cate, and over three million dollars was provided 
for construction and the purchase of land. 

No sooner was the line put into operation, how- 
ever, than it was found that the engineers had 
made serious blunders in their calculations. The 
people of the towns through which the new line 
ran were entirely satisfied with the service fur- 
nished them by the steam line. The trains were 
frequent and were seldom crowded. Passengers 
were delivered at a station in the centre of the 
city. The new suburban line, on the other hand, 
could give them only connection with the city 
line, necessitating a change of cars, which was 

inconvenient. The residents of these towns were, 

64 



THE BANKING HOUSE 

for the most part, well to do. The advantages of 
saving a few cents in their fare did not particularly 
appeal to them; neither did the more frequent 
service offered by the electric line prove much of 
an inducement, since the bulk of the traffic was 
hauled at the beginning and end of the day. As 
a consequence, the traffic of the new line proved a 
sore disappointment to the promoters. It failed 
from the beginning to pay its fixed charges, and 
for a considerable time even its operating expenses 
were not earned. It has since been sold at less 
than one-third of the amount of money invested 
in its construction; an expensive extension has 
been built to make it profitable; and the original 
syndicate has suffered a heavy loss. 

Another case related to a water-power enter- 
prise in a Southern State. The original estimates 
of the cost of construction in this case were 
$1,900,000, but these estimates were so radically 
defective that when the project was about half 
completed the money was exhausted. The prop- 
erty was placed in the hands of a receiver, who, 
on the basis of expert engineering investigation, 
estimated that over $1,500,000 would be required 
to complete the project. The promoting syndi- 
cate was forced to sell the half completed plant 
5 65 



THE CAREFUL INVESTOR 

at a heavy sacrifice, and it has since been completed 

by another company. 

Mr. H. M. Byllesby, the Chicago engineer, in 

a recent address on the securities of water-power 

companies as investments, mentions the following 

instance as an example of the great danger of 

underestimating the cost of new enterprises : "In 

developing a large and very necessary reservoir, 

they made some soimdings (but not enough), 

they dug some test pits (but not enough), and 

located what they believed to be a rock ledge, 

upon which they have begim to build a dam to 

impoimd the water in the reservoir; and now, 

after having closed the door for the raising of 

further funds, they find themselves in an extremely 

embarrassing position, because, contrary to all 

geological data at their command, contrary to 

the showing of their test pits, this ledge of rock, 

instead of drifting imiformly across the gorge 

where the dam is being built, has developed a 

'fault ' at the centre, of imknown depth, and which 

can only be bridged over or made safe by the 

expenditure of about twenty-five per cent, of the 

cost of the project. If it were not for the fact 

that the men back of this enterprise have large 

individual personal means and ample credit, the 

66 



THE BANKING HOUSE 

raising of this additional money . . . would 
probably force this particular enterprise to a dras- 
tic reorganization . ' ' 

In cases like the above, and they are numerous, 
mistakes in estimates are made, some unavoidable, 
but most of which could have been prevented by 
the employment of good engineers. If the inves- 
tor buys securities offered on behalf of a new com- 
pany, he is almost certain to buy into the effects 
of some such blunders as I have indicated. The 
banking house, on the contrary, takes pains to 
avoid such mistakes by making an investigation 
of the proposition, an investigation so thorough 
and so searching that no important defect will be 
left undisclosed. 

The following is an outline of the method of 
investigation employed by a prominent banking 
house when requested to purchase an issue of 
corporation securities : 

This house is averse to purchasing so-called 
''imseasoned'* or construction bonds. An enter- 
prise may be never so promising in prospect, and 
yet, if it has no established record of earnings, no 
balance sheet and income account to present, if 
its earnings are still on paper, this house will refuse 

to have anything to do with it. 

67 



THE CAREFUL INVESTOR 

New enterprises are best promoted and financed 
by construction syndicates. Banking houses may 
take an interest in these syndicates as promoters, 
expecting to make a portion of the promoters' 
profits; they may invite some of their own cus- 
tomers into the syndicate, not as investors, but 
as promoters Hke themselves ; but they will take 
good care that the enterprise has passed the con- 
struction stage, that a full fiscal year has been 
completed, and that a comfortable margin over 
interest charges is shown by the income account, 
before they make any public offering of the 
bonds. 

Even when bonds are seasoned, however, they 
will not be offered until the condition of the com- 
pany issuing them has been subjected to an ex- 
haustive analysis. The owners are first requested 
to submit complete data regarding the company, 
which are analyzed in the office of the banking con- 
cern. If no weakness is disclosed, such, for exam- 
ple, as stationary population, or too high a per- 
centage of interest charges to gross earnings, the 
formal examination begins. First comes the ex- 
amination of the engineer. Only expert engineers 
of long experience and high reputation, men quali- 
fied by familiarity with corporations of the class 

68 



THE BANKING HOUSE 

under examination, are employed. The engineer's 
examination goes into the condition of the prop- 
erty, the character of the management, the ade- 
quacy of the rates charged to the customers, the 
relations between the company and its em- 
ployees, the physical value of the corporation's 
property, and the chances of growth in the com- 
munity in which it operates. 

Next comes the audit of the corporation's 
accounts. Many banking houses employ their 
own auditors for this purpose. In the absence of 
such a skilled employee, they rely upon the advice 
of outside accoimtants of standing and experience. 
The object of the audit is to see, first, that the 
accounts are so kept that they show the actual 
condition of the company, and second, to deter- 
mine whether, for example, such items as the cost 
of power or the cost of maintenance are abnormally 
high. 

The banking house also insists upon a careftil 
legal investigation. This relates primarily to the 
franchises under which the company is given the 
right, for a term of years, to use public property 
for its own purposes. The banker's attorney will 
make sure that these franchises are sufficiently 
broad for the purposes of the company ; that they 



THE CAREFUL INVESTOR 

do not impose burdensome restrictions; that they 
run for a sufficient time to enable the business to 
be properly developed; and that they contain 
satisfactory provisions for renewal at their expira- 
tion. 

The attorney also gives much thought to the 
preparation of the mortgage under which the 
property of the company is conveyed to the trustee 
for the securing of its bonds. The mortgage will 
set forth, in great detail, the property which is 
transferred. It will bind the company by stringent 
provisions to maintain the value of this seciuity 
intact, and it will carefully limit and safeguard 
the future issues of bonds secin-ed by the same 
mortgage, so that a large margin of security in 
the cost of the property will be assured to the 
bond-holders. 

If, after this investigation, the banker is con- 
vinced that the bonds are safe, and that their 
safety will so increase that any one buying these 
bonds will be assured of a fixed income for a 
term of years, and the return of his principal 
at the end of the term, the banker will pur- 
chase the bonds, and will then offer them to his 
customers. 

The investor has none of the equipment for 
70 



THE BANKING HOUSE 

making an investigation of this kind. If he relies 
upon the representations of the promoters of any 
scheme, he is almost certain to be misled. If he 
attempts to investigate the proposition for him- 
self, his failure is likely to be both ludicrous and 
lamentable. If, however, he relies upon the 
recommendations of a banking house of standing, 
there is Httle chance of his losing his money. 



THE BUSINESS OF THE INVESTMENT- 
BANKER 

In the field of security investments, the buyer 
should seek information on three points: (i) 
Shall I purchase stocks or bonds ? (2) From whom 
shall I purchase my securities? (3) In what in- 
dustries shall I invest? The first question was 
answered in the last chapter. We have now to 
take up the second question: From whom shall 
I purchase my bonds? 

The security business, in its organization, re- 
sembles any other business. There are the manu- 
facturers, the companies which issue the bonds; 
the distributors — ^investment -bankers, investment 
or finance companies, savings-bank and insiu*ance 
companies, which purchase bonds from the pro- 
ducers, and, directly or indirectly, place them in 
the hands of the consimier; and finally the con- 
sumer, the investor, the policy-holder, or the 
savings-bank depositor. In the field of merchan- 
dise distribution, there are some producers who 

deal directly with the consumer, but these are the 

72 



THE INVESTMENT-BANKER 

exceptions. Generally speaking, the producers of 
shoes, hats, groceries, and drygoods have found it 
economical, and in all other ways satisfactory, to 
deal with the wholesaler. The jobber will buy in 
round lots from the manufacturer, taking his 
entire season's output of a certain line, assuring 
him his money without risk or trouble of collec- 
tion, and enabling him to make his financial and 
industrial plans on a basis of assured receipts. 

It is even more advantageous for the manu- 
facturer of bonds, the borrowing company, to deal 
with the bond- jobber, the investment-banker. 
The investment-banker is in most cases a partner- 
ship. If of the first rank, the concern will have a 
large capital, and a credit with banks and trust 
companies several times the amount of its capital. 
The investment-banker will also have associations 
with other houses of the same kind, which will 
place at his disposal large sums of cash whenever he 
requires. The business of the investment-banker 
is the purchase and sale of securities. He some- 
times adds to this other functions similar to those 
performed by a commercial bank, such as receiving 
deposits subject to check, and the purchase and sale 
of bills of foreign exchange. His main business, 

however, is dealing in investment securities. 

73 



THE CAREFUL INVESTOR 

The investment-banker, the jobber of bonds, 
organizes his business on the lines of a hardware 
or dry goods jobber. He has in his files the names 
of a large nimiber, sometimes many thousands, of 
present, prospective, or potential customers. He 
knows about how much money each has to invest, 
and the approximate dates when this money is 
available. He has an organization of salesmen 
who visit these customers, impressing upon them 
the merits of the securities offered by their house. 
The work of the salesmen is supplemented by 
letters, circulars, and public advertising. Some 
of the large houses extend their operations to 
foreign countries. They can draw upon the invest- 
ment resources of France, Holland, England, and 
Germany. The investment-banker sells largely to 
institutions — ^insurance companies, trust compa- 
nies, state and national banks. 

These security jobbers stand ready to purchase 
for cash the bonds and sometimes the stocks of 
corporations and mimicipalities. The prices which 
they offer the corporation are, of course, below the 
prices which they expect to receive — ^four points 
on some bonds, ten points on others. Out of the 
difference they pay their expenses and make their 
profit. It is nearly always advantageous for both 

74 



THE INVESTMENT-BANKER 

the security producer (the corporation) and the 
security consumer (the investor) to deal with the 
security jobber. 

To the corporation, the advantage of dealing 
with the investment-banker are evident. To begin 
with, when the contract with the banker is signed, 
the cost to the corporation of obtaining the money 
which it requires is determined. The bonds may 
be sold at 85, 87 >^, or 95. No matter what the 
price, the cost of the money is known. This money 
will be paid over to the corporation either at defi- 
nite dates or on demand. Contracts can be made 
for cars, or locomotives, or bridge material, with 
absolute certainty that the money to pay the bills 
will be in hand. 

The cost to the corporation of selling securities 
direct to in vestment- jobbers is usually much less 
than the cost by the alternative method of direct 
sale to the investor. The certainty of return, 
moreover, is far greater. The banker has a per- 
manent organization and an established clientele 
of customers. The organization is constantly at 
work marketing bonds and many of the customers 
are steadily buying. Most of the older houses 
control the security trade of a large part of their 

clientele who will buy from no one else. The 

75 



THE CAREFUL INVESTOR 

investment-banker can count on a certain amount 
of money from these customers at regular intervals. 

It is not necessary for the banker to force his 
bonds on an im willing market. By utilizing his 
credit, the banker can usually borrow up to 80 per 
cent, of the cost of these securities which they 
have purchased. 

An established banking-house can also employ 
the method of trading a new issue for an old. Their 
regular customers, upon whom the bankers can rely 
to buy their quota of any new issue, may have 
purchased all the bonds they can pay for. They 
have, however, old bonds with established records 
of interest payments, so-called ''seasoned" bonds, 
which are readily salable. The bonds of the new 
issue are now exchanged for the "seasoned" bonds 
on terms which show a profit to the holder of the 
old bonds. For example, he is allowed to buy a 
$1,000 bond which would cost him $950 in cash 
for $ 9 5 o in old bonds . The old bonds thus acquired 
by the bankers can be sold perhaps for 97, although 
they might have difficulty in selling the new bonds 
at 93. 

Finally, the investment-banker has the great 

advantage of associations in the same line of trade. 

Unlike the merchandise jobber, he has developed 

76 



THE INVESTMENT-BANKER 

to a high degree the methods of cooperative buy- 
ing. When a new issue of bonds is to be purchased, 
he can quickly form a purchasing syndicate con- 
taining perhaps twenty other houses, located in 
all parts of the country. He has thus at his dis- 
posal twenty selling organizations and groups of 
investors in addition to his own. 

Sharply contrasted with the superior advantages 
of the investment-banker as a distributor of securi- 
ties, is the situation of the corporation which tries 
to do this work for itself. A corporation engaged 
in the mining of coal or the operation of an electric 
railway does not possess any of the elaborate equip- 
ment necessary for the sale of large amounts of 
securities on short notice. Since its demands for 
new capital are occasional, dependent upon its 
need for larger facilities, a company may run along 
for five or six years without selling any securities. 
There would be no occupation for a securities 
selling department under these circumstances. 
Any company, even a strong corporation, desiring 
to sell bonds outside the circle of its own stock- 
holders must construct a special organization for 
the purpose and at the time. Such an organiza- 
tion is expensive and inefficient. The company 

must rely on newspaper advertising to discover 

77 



THE CAREFUL INVESTOR 

its prospective customers, and this is a very ex- 
pensive method. 

Again, most companies have difficulty in bor- 
rowing from banks on the security of their own 
bonds, although the same security may be entirely 
satisfactory to the same banks when offered by 
the investment-banker. The cost of selling, and 
the proceeds of sale, imder these conditions, would 
be equally tmcertain. The corporation could not 
laimch any extensive building programme, while 
relying upon so precarious a soiu*ce from which to 
meet its contract obligations. 

So important and so plain are the advantages 
of selling bonds to bankers instead of attempting 
to reach the investor direct, that the method of 
direct appeal is adopted only when necessity con- 
strains. The manufacturer of shoes may decide 
to do without the jobber, and may estabHsh his 
own chain of stores through which he may market 
his product direct. The wisdom of this method 
is doubtful as a general practice, but in a few cases 
it has undoubtedly succeeded. But the shoe- 
manufacturer is making shoes all the time. His 
factory runs continuously, if he can seU its output. 
His business is to manufacture and to sell shoes. 

The manufacturer of railroad securities, how- 
78 



THE INVESTMENT-BANKER 

ever, only starts this portion of his productive 
machinery running when he needs money to build 
a new line, or to reduce grades, or to excavate 
timnels, in order to reduce the cost of train move- 
ment. His business is to transport passengers 
and freight, not to make pig iron or cotton cloth. 
The raising of new capital by the sale of bonds or 
stocks is incidental and contributory to his main 
business. It is difficult to imagine a situation 
where it will be advantageous for a corporation, 
imless its own stock-holders are able to supply 
its need for new money, to offer its securities 
direct. 

The conclusion, from the standpoint of the 
investor's interest, is plain. Whenever the invest- 
ment-banker will buy, the corporation with bonds 
for sale will sell them to the investment-banker. 
Only when the banker will not purchase, or, as 
shown above, when the stock-holders of the com- 
pany desiring to raise new capital are willing to 
add to their investment, will any other method 
than sale to the investment-banker be adopted. 
If, now, we find that the investment-banker will 
buy only the best bonds for sale to his clients, it 
is a safe conclusion that if the investor wishes good 

secxirities, he can rely upon getting them nowhere 

79 



THE CAREFUL INVESTOR 

else than from the bankers whose business it is 
to select such securities and to sell them. 

A moment's consideration of the case will suffice 
to show that the success of the investment-banker 
depends upon the quality of the bonds which he 
offers for sale. He expects his business to be per- 
manent with every client. When a man has saved 
$i,ooo and purchased a bond, it is a reasonable 
presumption, from the banker's standpoint, that 
he will repeat the operation many times, and the 
banker intends that, as far as possible, he shall 
supply the investments for the succeeding thou- 
sands also. Again, if the banker sells a bond 
maturing in ten or twenty years, he has a record 
of that sale, and when the bond is paid off he 
expects to have a new bond ready to take the place 
of the old one. He aims to cultivate, therefore, 
by every means in his power, the good-will of his 
customers. The number of investors, considered 
in relation to the total population, is small. Com- 
petition for their money is very keen. When once 
a prospect has been converted into a customer, the 
banker has the strongest possible motives of self- 
interest to keep him for a permanent customer. 

The basis of the customer's good-will, the foun- 
dation upon which a large security-selling business 



THE INVESTMENT-BANKER 

must be erected, is the high quality, the impreg- 
nable security, of the bonds which the banking- 
house offers for sale. In his literature, in his 
advertisements, and through his salesmen, the 
banker lays strenuous emphasis upon the safety 
of his wares. He recommends them to his cus- 
tomers. Usually he has bought them for himself 
before he offers them for sale. His constant en- 
deavor is to protect his customers against loss. 
He will carry this solicitude for the customers' 
good- will so far, in some cases, as to repurchase 
bonds concerning whose value questions may have 
been raised, or whose reputation has been blown 
upon. He has been known to undertake, at his 
own risk, the work of reorganizing bankrupt com- 
panies whose bonds have passed through his hands, 
so that they may, without loss to the creditors, 
be started anew. 

A man in such a business cannot afford to 
recommend to his customers bonds concerning 
whose soundness there may be any question. To 
depart from this rule means the ultimate destruc- 
tion of his business. He may, as some bankers 
have done, sell a large amount of doubtful bonds 
or stocks during a period of business prosperity, 

when all enterprises, both bad and good, were 
6 81 



THE CAREFUL INVESTOR 

making money. He may trade upon the con- 
fidence of his cHents and temporarily enrich him- 
self at their expense. But when a business depres- 
sion overtakes these shaky enterprises which he 
has financed they go down in ruin, and with 
them goes the good- will of the banker's business. 
We arrive, then, at this conclusion: since it is 
to the interest of corporations having bonds for 
sale to sell them through investment-bankers, and 
since it is to the interest of the investment-banker 
to pvirchase only safe bonds, it follows that safe 
bonds of new companies, those which are offered 
at attractive prices, can be purchased, as a rule, 
only through the investment-banker. 



VI 

THE RELIABLE INVESTMENT-BANKER 

The question is often asked, Does the invest- 
ment-banker guarantee the securities that he sells ? 
His literature abounds with assurances that any 
one who purchases his wares will not lose. The 
investment-banker, by his own representations, 
deals in securities. Whoever intrusts his money to 
him may sleep soundly, undisturbed by fears of 
loss. These representations are, moreover, true. 
Only a small, almost negligible fraction of the 
bonds placed through banking-houses of the first 
class are ever in trouble. 

Still, losses and defaults sometimes occur. I 
have before me a circular letter addressed to the 
bond-holders of a manufacturing concern, now in 
receivers' hands, by a protective committee, in- 
viting deposit of bonds for mutual defense and 
protection. The St. Louis and San Francisco 
bond-holders are making similar appeals. Such 
cases of default are fortimately rare. They do 
occur, however, and the investor who is thinking 

about the purchase of bonds will do well to have 

83 



• THE CAREFUL INVESTOR 

them in mind. By electing to take a bond rather 
than a share of stock, the investor has abandoned 
all claim to share in the profits of the business 
above the five or six per cent, which will be paid 
to him as interest. He has decided to choose safety 
of principal and a fixed income. He wishes some 
guarantee and assurance that his principal will be 
safe and his income secure. Can the investment- 
banker give him this assmrance ? 

On some points the investor can feel satisfied, 
provided he deals only with banking-houses of 
proved reputation. He can be sure that, barring 
the "acts of God and the public enemy," his 
investment will be safe, that his interest will be 
paid him regularly, and that when his bond 
matures the money will be ready. If war or revo- 
lution destroys his investment, if fire, flood, earth- 
quake, or tornado falls upon the property which 
secures his bonds, he may suffer a partial or total 
loss. Short of such calamities, however, which 
no foresight can anticipate, against which no 
forethought can provide, the conservative invest- 
ment banker can assure his customers absolute 
protection. 

He can give them this assurance because he has 
thoroughly investigated the security of the bonds 

84 



RELIABLE INVESTMENT-BANKER 

which he sells. He has satisfied himself that all 
legal safeguards are thrown about the borrower, 
that the physical condition of the property is 
sound, that the total bond-issue is less than the 
replacement value of the property, that the earn- 
ings are well above the interest charges, that the 
management is capable and progressive, and that 
the demand for the product or service — the gas, 
or water, or electricity, or transportation — ^which 
the company is organized to furnish, is reasonably 
certain to increase. By the banker*s investigation, 
every unknown factor has been eliminated. He is 
offering certainties to his customers ; he sells them 
a secured income and a secured return of principal. 
But still one question has not been answered. 
What is the backing of these assurances? What 
guaranty does the banker give that his represen- 
tations and his promises will be borne out by 
the result? If you purchase a house, you apply 
for title insurance. For a small fee, a trust 
company places its surplus and capital back of 
your title. It gives you absolute assurance that 
you will suffer no damage from any defect in 
your title. Does the investment-banker give the 
same assurance? 

Suppose, for example, that you buy $5,000 bonds 
85 



THE CAREFUL INVESTOR 

secured by a mortgage on a trolley system, and 
that, after a few years, yoiir interest fails to be 
paid. A receiver is appointed for the property. 
A reorganization plan is offered the bond-holders. 
What, then, will be the attitude of the banker 
who sold you the bonds? Will he make good your 
loss, or will he cite to you the ancient proverb, 
the swindler's city of refuge, *' Caveat Emptor'' 
(Let the buyer beware) ? Is the banker's guaranty 
worth anything ? Has it substance ? Granted that 
it is only a moral guaranty, will the banker make 
it good? 

I can answer this question by citing an instance. 
About twelve years ago, a newly organized banking- 
house, anxious for business, purchased, after what 
it believed to be sufficient investigation, an issue 
of bonds secured by a mortgage on a city street- 
railway. They had employed in the investigation 
a well known accoimtant, a man who at that time 
enjoyed a national reputation because of sensa- 
tional disclosures of railway mismanagement. The 
accoimtant did not conduct the investigation 
personally. He sent his son in his stead, but he 
signed the report of earnings and expenses on the 
basis of which the banking-house purchased and 
sold the bonds. 



RELIABLE INVESTMENT-BANKER 

Shortly afterward, default in interest occurred. 
The bankers were astonished. They investigated. 
They found that their representative had been 
misled. He had accepted figures of earnings which 
were grossly exaggerated. The management, in 
order to make the necessary showing of earnings, 
had sold large quantities of tickets at wholesale 
rates, which the company had to redeem in trans- 
portation. These ticket-sales were coimted as 
earnings. Expert accountant fils accepted the 
figures, which included these advance sales, as 
accurate representations of the financial condition 
of the company. Expert accountant pere signed 
his son's report. The bankers had been grossly 
deceived by their incompetent representative. 
The company could not pay its interest. Its bonds 
were in default. Many of these bonds had been 
sold. What was to be done? 

The bankers recognized that they were to blame. 
The investigation had been faulty. They had 
failed in their duty. They must take the conse- 
quences. They immediately offered to repurchase 
all bonds of this issue at the price paid. They 
actually did repurchase more than $300,000 of 
them, and carried them for seven years before they 

were able to recover the loss. 

87 



THE CAREFUL INVESTOR 

Their case illustrates the nature as well as the 
limitations of the banker's responsibility. He must 
not misstate the facts about an investment to his 
clients. On the basis of these facts, he recommends 
the purchase of bonds as safe investments. If, 
however, the true state of affairs is not known to 
the banker ; if, in ignorance of facts, a knowledge 
of which woiild make him refuse the purchase, 
he buys bonds and sells these to his customers, 
he is then morally bound to protect his customers 
against loss. A reputable banker will not shirk 
this obligation. He will not announce in his cir- 
culars that he will make good his customers' losses. 
He will not authorize his salesmen to make this 
statement. He will not formally admit his re- 
sponsibility. But when the loss occtirs, if it is his 
fault, or the fault of his agents who have not 
placed the true facts of the proposition before him, 
he will protect his customers. 

Such cases are rare. I knew of one banking- 
house which had been in business for thirteen years, 
and which had had only two defaults among him- 
dreds of issues which it has placed with investors. 
In only one case was the house responsible because 
of faulty investigation. In both cases its customers 

were protected. Another house has had three 

88 



RELIABLE INVESTMENT-BANKER 

defaults in the same number of years, both due to 
technical and temporary causes. In each case the 
customers were protected. 

Sometimes the banking-house will not go so far 
as to buy back defaiilted bonds. If the company 
is sound, and the embarrassment certain to be 
temporary, the banker must take another course 
to protect his customers. A prominent banking- 
house of high reputation sold a large issue of bonds 
sectired by a mortgage on the property of a public- 
service corporation. The bonds were perfectly 
secured, assimiing that the management was 
honest. The stock-holding control of this com- 
pany, however, thought to play a sharp trick on 
the bond-holders. They diverted earnings from 
interest into improvements, defaulted on the 
bonds, and secured the appointment of a receiver, 
thinking to force a compromise with the bond- 
holders. 

The banking-house which had placed the bonds 

immediately took charge. They laid the true 

state of affairs before the bond-holders. They 

assured them that their investment was perfectly 

safe. They invited their cooperation in wresting 

the control from the dishonest management. Most 

of the bond-holders placed their interests in the 

89 



THE CAREFUL INVESTOR 

hands of the banking-house which took charge of 
the reorganization, securing for the bond-holders 
in the new company not only the same interest 
which they had in the old company, but securities 
representing a large share of the profits in addition. 
This house has lost nothing of its high reputation 
by the course of action which it pursued in this 
matter. 

I have said that the reputable investment- 
banker will always protect his clients. Yet how 
is the investor to distinguish between the repu- 
table investment-bankers and those who look 
on bonds as the peddler regarded razors, as pri- 
marily made, not for service, but for sale. We 
can find plenty of bankers who will not protect 
their customers, who use them like a flock of 
sheep, shearing them from time to time, and yet, 
by some strange credulity which infests the minds 
of a certain type of investors, keeping their hold 
upon them. 

I am familiar with the history of one of these 

firms. Strangely enough, its reputation is high 

in its city and State. Its members are counted 

among the prominent financiers of their commim- 

ity. Its list of clients is long and loyal. This firm 

has sold a number of issues of bonds whose security 

90 



RELIABLE INVESTMENT-BANKER 

was bad and which have been in default. The 
head of the firm is quite frank about the matter. 
He once said that his customers did not mind 
bankruptcy. They were willing to go through 
reorganization. Some day they would make some 
money. A member of this firm expressed mild 
surprise at the painstaking investigation which 
another house thought it necessary to make before 
buying some bonds. He was asked how his house 
proceeded. "Well," he replied, "I guess we buy 
bonds by instinct." The record of his firm bears 
out his statement. 

There is only one sure test of the character of a 
banking-house — ^its record of flotations. If we 
could have for every investment-banker who offers 
his wares to the public, a list of the bonds and 
stocks which he has offered for sale, the represen- 
tations made at the time of issue, and the subse- 
quent history of these securities, we should have 
a nearly infallible guide to his trustworthiness. 
Such a compilation could be easily made. It 
would, however, furnish a series of comparative 
revelations as to the records of various banking- 
houses, which would not only be illuminating but 
amazing. On the basis of such a record, the inves- 
tor could place his money in fuU confidence that 

91 



THE CAREFUL INVESTOR 

the houses from whom he purchased were worthy 
of his trust. I suggest to every investor that, 
before buying any secmities, he investigate the 
record of the house which offers them. In most 
cases he will find that record both fair and honor- 
able. Such an investigation, however, may save 
him from loss. 



/ 



VII 

PUBLIC OBLIGATIONS— MUNICIPAL 
BONDS PREFERRED 

For the conservative investor who looks for 
absolute safety of principal, and who is willing 
to make some sacrifices of income in order to secure 
absolute safety, the municipal bond has the first 
choice. United States Government bonds, it is 
true, are safer, but the demands for these bonds 
from national banks, who use them as a basis for 
circulating notes, and to secure deposits of money 
with them by the government, is so great that 
they yield little more than 2 per cent. This yield 
is too small to be attractive even to the most con- 
servative investor. Of the government bonds out- 
standing amoimting to $963,349,390, $193,526,090 
are held by national banks. 

State bonds are distinctly inferior to mimicipal 
bonds. In the eleventh amendment to the Con- 
stitution of the United States it is provided that 
"the judicial power of the United States shall not 
be construed to extend to any suit in law or equity 

commenced or prosecuted against any of the 

93 



THE CAREFUL INVESTOR 

United States by citizens of another State, or by 
citizens or subjects of any foreign state.*' Under 
this amendment, any State may repudiate its obli- 
gations, and a nimiber of States have done so, at 
different times, and for a variety of reasons. Fol- 
lowing the panic of 1837, during a period of severe 
industrial depression, Pennsylvania, Maryland^ 
Indiana, Illinois, Michigan, Florida, and Missis- 
sippi repudiated their debts, declared, in effect, 
that they were unable to pay their creditors. Of 
the four Northern States, Michigan was the only 
one which did not eventually pay in full. In the 
South, Florida and Mississippi were guilty of 
deliberate repudiation. Minnesota, in i860, re- 
pudiated certain bonds issued in aid of railroad 
construction. These bonds were eventually re- 
deemed at fifty cents on the dollar, with accrued 
interest. Following the Civil War, came a wave 
of repudiation in the South. From 1870 to 1884, 
nine Southern States defrauded their creditors by 
stopping payment on the bonds. A large part of 
this debt was due to the extravagance and rascahty 
of the ''carpet-bag" period, and these abuses were 
urged in defense and extenuation of the wholesale 
repudiation of written obligations. Whatever the 
cause, by 1870 the bonds of the Southern States 

94 



PUBLIC OBLIGATIONS 

in default had reached $170,025,340, an increase 
of $82,257,650 over the amount of defaulted debt 
in i860. 

There is a kindly and classical explanation of 
the tendency of the Southern States to repudiate, 
which applies, however, mainly to antebellum de- 
fatdts. Mr. Justice Curtice, in an article in the 
North American Review for January, 1844, referring 
to a repudiation of debt by the State of Mississippi, 
says : 

To pay debts punctually is the point of honor among commer- 
cial peoples. But the planters of Mississippi do not so esteem it. 
They do not feel the importance of an exact conformity to con- 
tracts. It has not been their habit to meet the engagements on 
the very day, if not quite convenient. Certainly they attach no 
idea of dishonesty to such a course of dealing. They mean to 
pay, but they did not expect when they contracted the debt to 
distress themselves about the payment. If a friend wants a 
thousand dollars for a loan or a gift, he can have it, though per- 
haps a creditor wants it also. We do not mean to intimate that 
there are no high qualities in such a character, but they are 
different from those which make good bankers or merchants, and, 
therefore, bankers and merchants ought not to expect such men 
to look at a debt just as they do. 

To explain the repudiation of the carpet-bag 
debts, we can resort to an illustration in another 
field. One of the favorite methods of swindling 
the farmer twenty years ago was by securing his 
signature to a doctmient, one-half of which was a 

95 



THE CAREFUL INVESTOR 

receipt, or bill of sale, or some such innocent thing, 
and the other half, which was folded iinder so as 
to be concealed from the victim's gaze, was a 
promise to pay. The innocuous part of the docu- 
ment would subsequently be cut off, and the 
promissory note, signed in ignorance of its real 
nature, and by the victim of a gross and palpable 
fraud, would be discounted at a bank. In time, 
this note would be presented for payment by the 
bank, an innocent holder for value, and entitled 
to collect on the fraudulent note. 

In order to comprehend the attitude of the 
people of North Carolina or Mississippi toward 
their bonds issued dining the reconstruction period 
we have only to picture the attitude of mind of 
the aforesaid farmer, supposing there was no law 
protecting the innocent holder for value of a 
negotiable instnmient, when the bank which had 
purchased one of these fraudulent, though in form 
genuine, notes, asked for payment. Would he 
pay such a note? We think he would not. He 
would not even extend to the banker his sympathy. 
He would laugh in derision at the banker's calamity. 

Now, this is exactly the attitude of the Southern 

States. There is no law which compels them to 

pay their debts. The construction of the United 

96 



PUBLIC OBLIGATIONS 

States makes them im^mune from prosecution. No 
one can touch them. These debts, they claim, are 
tainted with fraud. They will not pay them, and 
look the whole world in the face when they say it. 

There will come a time when these debts will 
be paid. These Southern States will need money 
for public improvements. In order to sell new 
bonds, they must first settle with existing creditors. 
This will not be a matter of sentiment or honor, 
but of business. When that time comes State 
bonds will improve their standing. At present, 
however, although some States, such as New York, 
enjoy excellent credit, the reputation of State 
bonds as a class is somewhat frowned upon. 

Municipal bonds stand upon a different footing. 
Instead of the optional honesty of the State, an 
honesty depending on the prevalence and pre- 
dominance of the commercial spirit among her 
citizens, and upon the necessity of appealing from 
time to time for new loans to the creditors, we 
find in the municipal bond the guaranty of a 
secured obligation. Even in those States which 
have repudiated their written obligations, these 
smaller political units, the municipalities, enjoy 
excellent credit. Their bonds are in good demand, 

because both principal and interest are secured. 
7 97 



THE CAREFUL INVESTOR 

The explanation of this difference is found in the 
fact that these smaller governmental bodies do 
not enjoy the same immunity as the State. They 
can be sued by the creditor. 

We hear much about the good faith of the 
public. We are told that it represents the distilled 
essence of a multitude of private consciences, that 
it is a higher, nobler, more dependable thing than 
the good faith of the individual. This view of 
public honor is not entirely correct. Edmimd 
Burke, in his "Reflections on the Revolution in 
France," speaks of a perfect democracy as "the 
most shameless thing in the world." As he says: 

The share of infamy that is likely to fall to the lot of each 
individual in public acts is small indeed, the operation of opinion 
being in the inverse ratio to the ntmiber of those who abuse 
power. Their own approbation of their own acts has to them the 
appearance of a public judgment in their favor. 

And in another place: 

Society requires not only that the passions of Individuals 
should be subjected, but that even in the mass and body, as well 
as in the individual, the inclinations of men should frequently be 
thwarted, their will controlled, and their passions brought into 
subjection. This can only be done by a power out of themselves, 
and not, in the exercise of its function, subject to that will and 
to these passions which it is its office to bridle and subdue. 

The State may be taken as the perfect de- 
mocracy to which Burke refers. Some American 

98 



PUBLIC OBLIGATIONS 

States are shameless, though populous with men 
honorable in all private business relations. The 
towns and cities of these States, however, are cor- 
porations, chartered by the State for the perform- 
ance of the local functions of government, author- 
ized to borrow money, and compelled by the law 
to repay what they have borrowed, by a "power 
outside of themselves." 

The security of a municipal bond is twofold: 
first, the property not used for the purpose of 
government which the city may own, and which 
can be sold imder execution in satisfaction of a 
judgment; and, second, the obligation of the 
municipal officers, when ordered to do so by the 
court, to levy taxes for the payment of principal 
and interest of their debts. 

Some States provide in their constitutions that 
when a debt is incurred, provision must be made 
by taxation to repay the debt at maturity, and, 
in the meantime, to pay the interest. It is a gen- 
eral rule also, even when the constitution does 
not provide for such a tax, and also to supplement 
the constitutional requirement, that the local 
authorities should, by mimicipal ordinance, pro- 
vide for the tax. Even without special provisions 
in State constitution or local ordinance, the gen- 

99 



THE CAREFUL INVESTOR 

eral power of taxation can be invoked by the 
creditor in case of default, and cotirt orders can 
compel public officers to levy the tax. 

Municipal bonds differ from the bonds of pri- 
vate corporations in that they must be issued in 
strict compliance with the law. The history of 
municipal borrowing in the United States abounds 
with instances of folly. Bonds have been issued 
in aid of public improvements which never ma- 
terialized. Bonds have been sold to enormous 
amounts whose proceeds never found their way 
into the public treasury. Every financial wrong 
inflicted on the Southern people by the recon- 
struction governments can find its coimterpart 
in the borrowing by Northern mimicipalities. 
Learning wisdom by experience, the people have, 
in their State constitutions, and in the statutes 
imder which municipal corporations are char- 
tered, imposed upon those bodies a variety of 
restrictions. These restrictions, since they enforce 
caution and conservatism upon the mimicipal 
authorities, contribute also to the seciirity of the 
investor. 

In the first place, municipalities are generally 
prohibited from incurring debt in aid of any rail- 
road or other outside enterprise. The proceeds of 

100 



PUBLIC OBLIGATIONS 

municipal bond sales must be spent in and for the 
benefit of the borrowing community. 

The amount of the debt is closely limited. The 
standard of limitation is the assessed value of 
the property in the town or city. With few ex- 
ceptions, the assessed value is far below, usually 
little more than half, the market value. On the 
basis of this assessed value, cities are prohibited 
from incurring more than small percentages, 
ranging from i>^ to 15 per cent, of debt. A limit 
of five per cent, on the assessed valuation, a com- 
mon restriction, with an assessment of 50 per cent, 
of selling value, is equivalent to a stipulation that 
the city must not borrow more than 2^ per cent, 
of the amount at which its taxable property should 
be valued. 

The State also takes great care that loans 

should be incurred only after full deliberation by 

the municipal authorities; in many States, after 

the voters have had an opportimity to pass upon 

the wisdom of the loan. The utmost care is taken 

to secure complete publicity. In order that the 

highest price shall be obtained, competitive bids 

are invited, accompanied by certified checks for 

substantial amoimts as evidence of good faith. In 

every possible way, the State protects the public, 

101 



THE CAREFUL INVESTOR 

and, in so doing, protects the investor against 
excessive bond issues, for purposes of which the 
people do not approve, or for which the issuing 
municipalities do not receive full value. 

These legal restrictions on municipal borrowing 
while they protect the investor when observed, 
also make it necessary for him to be on his guard 
to see that they have been fully compHed with. 
When a railroad company issues bonds, every 
provision of its charter and by-laws may have 
been violated by the making of the loan, and yet 
the innocent holder of these bonds will be pro- 
tected. He is not supposed to have knowledge of 
or to be held responsible for the internal arrange- 
ments of the company to which he loans money. 
He has done his part by giving value for the 
bonds. If the company has been defrauded of a 
part of the proceeds of these bonds, or if they have 
been issued for a purpose which the charter for- 
bids, the company should look for compensation 
and reimbursement to those officials who are 
responsible. 

With a mimicipal bond, the case is different. 
The regulations which govern their issue are a 
part of the laws of their State. Every one is sup- 
posed to have knowledge of them. The bond- 

102 



PUBLIC OBLIGATIONS 

buyer must have these regulations in mind. He 
must assimie that they have been complied with. 
If, in any substantial respect, these regulations 
have not been closely followed, the bonds may be 
held invalid. A little book entitled "Municipal 
Bonds Held Void," by Maurice B. Dean, of the 
New York Bar, gives a complete list of those 
obligations in the purchase of which the creditor 
lost. From this digest I take the following: 

In 1904, $4,000 of bonds issued by the village 
of Grant, Nebraska, were held invalid "because 
they were issued in aid of private water- works," 
an imlawful purpose. As authority for their 
issue, the bonds referred to a statute which did 
not convey authority. The court said: "The 
bonds, therefore, bear upon their face ample evi- 
dence of their own invalidity, and no one can 
claim to be a bona fide purchaser of a bond which 
carried on its face evidence of its unlawful char- 
acter." 

A Michigan case is even more significant. The 

village of Ashley sold $8,500 of water- works bonds 

imder a resolution of the village council, which, 

while it authorized the president and clerk to sign 

water- works bonds, did not authorize the president 

to deliver the bonds. The bonds, having been 

103 



THE CAREFUL INVESTOR 

delivered without authority, were held to be void, 
although in the hands of a bona fide holder." 

An Indiana case shows how far the taint of ille- 
gality can persist. The city of Jeffersonville had 
issued and sold bonds to obtain money to contest 
litigation changing the county seat. At a later 
time it desired to take up these bonds with a new 
issue. The issue was enjoined by a tax-payer, 
and the original issue was held to be void because 
made for an illegal purpose." 

Out of this situation arises the need of a careful 
legal investigation before municipal bonds can be 
safely offered to the investor. The buyer of a 
municipal bond cannot be an innocent holder for 
value. Ignorance of the law cannot be urged in 
his favor. He is charged with constructive knowl- 
edge of any illegality in the procedure imder which 
his bonds were issued. If every requirement laid 
down in the law to govern the issue of the bonds 
has not been complied with, his bonds are invalid. 

This does not mean that the bond-holder will 

necessarily lose. He can still fall back on the 

good faith of the people, estimating this at its 

problematical value. But the trouble is that after 

bonds have been tainted with illegality, there is 

no legal way in which they can be paid, except 

104 



PUBLIC OBLIGATIONS 

by popular subscription, until the law is changed. 
The city of Helena, Montana, through no fault of 
its own, is unable to pay certain bonds which, 
owing to a decline in the value of the city's prop- 
erty, are issued to an illegal amount. The city 
stands ready to pay these bonds whenever a legal 
method can be found. Meanwhile the holders 
suffer loss. 

The bond-house purchasing an issue of munici- 
pals, therefore, centres its inquiry upon the legality 
of the issue. It takes into account other factors — 
the productiveness of the assets, such as water- 
works, which are to be constructed with the pro- 
ceeds of the bonds ; the population of the borrow- 
ing community, its record of good faith toward 
its creditors, the assessed value of the property, 
and any other factors which may bear upon the 
merits of the flotation as a business proposition. 

The chief concern of the banking house is with 
the legality of the municipal bond issue. Munici- 
pal, school district, and county bonds are good, 
if they are legal. The margin of a security in the 
value of a town's property over the total amoiint 
which it is allowed to borrow is so great as to 
eliminate the element of business risk which the 

purchaser of railroad bonds, for example, must 

105 



THE CAREFUL INVESTOR 

consider. The bond-house, for this investigation, 
relies upon the advice of the best lawyers it can 
secure. In some cases the opinions of two firms 
are taken. 

The lawyer's statement to the bond-house 
answers the following questions : 

(i) Is the city permitted by its charter and by the State con- 
stitution and Acts of Assembly to issue bonds for the purposes 
proposed? 

(2) Have the necessary formalities, such as passage of ordi- 
nances, approval by the mayor, etc., been taken by the city? 

(3) If necessary, has the bond issue been approved at an elec- 
tion, and in that case, has the election been conducted according 
to the prescribed form? 

(4) Have the legal stipulations concerning advertisement, 
secrecy of bids, and award to the highest bidder been complied 
with? 

(5) Is the amoimt of the issue within the limits set by the 
statute? 

(6) Is the form of the bond such that the city cannot escape 
responsibility by any technicality or slip in drawing up or word- 
ing the instrument? 

(7) Have the present bonds, or the bonds which it is proposed 
to refund with this issue, ever been subject to litigation? 

On the basis of these legal opinions, for which 
the bond-house must sometimes pay large fees, 
the bonds are offered to the investor, who may 
purchase them with absolute confidence in their 
validity. Mr. Lawrence Chamberlain, in his excel- 
lent work "The Principles of Bond Investment,'* 

106 



PUBLIC OBLIGATIONS 

states that in 1907, out of $200,000,000 of muni- 
cipal and State bonds issued, some $4,000,000, of 
2 per cent., divided among 65 municipal issues, 
were finally declined by those who had bought 
them subject to the approval of their attorneys, 
usually on the ground of their illegality. 

To show the care exercised in this matter, I 
recall an instance where a New York house refused 
to purchase an issue of school-district bonds, be- 
cause, while the law required that the notice of 
the election to authorize the bonds should be 
posted for a certain time on the front door of the 
school-house, it appeared that the notice had been 
posted on the side door. 

In some States — New Jersey, North Dakota, 
Texas, Georgia and Kansas — the law now pro- 
vides for a *' State certificate of validity" usually 
endorsed on the bond by some State official. When 
this safeguard is provided, a legal investigation is 
not absolutely necessary, although it will usually 
be made as an extra precaution. Elsewhere, how- 
ever, the investigation by the attorneys is indis- 
pensable to security. 



VIII 
HIGH-YIELD MUNICIPAL BONDS 

It is not going too far to say that the bonds of 
American cities rank among the safest investments 
in the worid. We find, however, that outside of 
institutions, especially savings-banks and the more 
conservative class of investors, mimicipal bonds 
are not popular. The reason is that in the section 
of the coimtry where most of the fimds available 
for investment are concentrated — the Northern 
States — ^the bonds of mimicipalities sell at much 
higher figures, thus offering little inducement to 
the investor. In the State of New York, for 
example, we find the prevailing yield on municipal 
bonds to be from 4 to 4.20 per cent. In New 
Jersey the rate sometimes runs higher, although 
some of the bonds of Newark, at the last quota- 
tion, yielded no more than 3.95 per cent, to the 
investor. In the New England States, the yield 
on mimicipal bonds is very small. The bonds of 
Boston yield only 3.90 per cent, and the bonds of 
Connecticut, w^hose quotations are available, show 
from 4.05 to 4.10 per cent. When we pass outside 

108 



HIGH- YIELD MUNICIPAL BONDS 

the North-eastern States we find an immediate, 
although only a moderate, advance in the yield 
on bonds. Bonds of Michigan range from a mini- 
mum of 4.50 per cent, to a maximum of 4.60 per 
cent. ; the mimicipal bonds of South Dakota run 
from 4.3oto4.65per cent . In Tennessee the range 
is about the same. In Texas some good mimicipal 
bonds can be purchased to yield 5 per cent. 

The difference between the yields of the muni- 
cipal bonds in the East, and in the West and 
South, is due to the concurrence of several influ- 
ences. The investment funds are largely concen- 
trated in the East. There is a prejudice in the 
minds of all investors in favor of the bonds of 
their own localities. This prejudice is also enacted 
into law in the restrictions placed upon the invest- 
ments of savings-banks. These banks are the 
principal buyers of municipal bonds, and the im- 
mense demands of these institutions are concen- 
trated upon a limited number of issues. For 
example, the savings-bank law of Massachusetts 
limits the investment of savings funds to the bonds 
or notes of any city of the five New England 
States, or of any county, town, or water district, 
which conforms to certain restrictions as to the 

relation between indebtedness and valuation. 

109 



THE CAREFUL INVESTOR 

Outside of New England, Massachusetts savings- 
banks can buy municipal bonds of New York, 
Ohio, Pennsylvania, Indiana, Illinois, Michigan, 
Wisconsin, Minnesota, Missouri, Iowa, and the 
District of Columbia, when issued by a city of 
more than 30,000 inhabitants, and where the net 
debt does not exceed 5 per cent, of the assessed 
valuation. 

Similar restrictions are found in all the States, 
and these restrictions have the effect of so con- 
centrating the demand for municipal bonds as to 
make a marked difference in their price. An issue 
by a small town in Massachusetts, for example, 
may be no better, nor even as good, as the bonds 
of Oklahoma City. The Oklahoma City bonds, 
however, will sell on a 4?^ per cent, basis, while 
the bonds of Pittsfield, Massachusetts, will sell 
on a 3^^ per cent, basis. There is no question 
about the honesty of the people of Oklahoma City, 
or of the value of their property, or of the industrial 
future of their city. The bonds of Oklahoma City 
are perfectly good. They are not, however, avail- 
able for a certain restricted class of investment, 
and there is a natural prejudice against them on 
the part of Eastern investors. This explains their 

low price and high yield. 

110 



HIGH-YIELD MUNICIPAL BONDS 

There is another class of municipal bonds issued 
by tax districts, which, when issued under proper 
restrictions, and purchased from reliable bond- 
houses, give the investor excellent security and 
high retiim. I have before me the 6 per cent, 
bonds of a certain levee district in one of the 
Southern States. The valuation of taxable prop- 
erty in this district is $1,250,000, and the total 
debt is $160,000. The present value of the land 
in the district is from $15 to $40 per acre. The 
issuing bond-houses state that land outside the 
district, which is not subject to flooding, sells 
from $75 to $100 per acre. The total area of the 
district is 59,596 acres, and the debt, per acre, is 
only $2.68, or less than 20 per cent, of the value 
of the cheapest land in the district. 

Another illustration of tax-district bonds comes 
from Seattle in an issue of $30,000 ten-year 6 per 
cent, bonds, issued for regrading certain streets 
adjacent to the main business centre of Seattle. 
A large number of offerings of this kind are avail- 
able to the investor. 

In view of these high interest rates, usually 

ranging from 5 to 6 per cent, or higher, and also 

because of the lack of familiarity of the Eastern 

investor with such issues, it is important to under- 
ill 



THE CAREFUL INVESTOR 

stand the security back of these bonds. All tax 
districts, such as school districts, levee districts, 
irrigation districts, or sewerage districts, are 
agencies of the State which have been estabHshed 
to serve local public purposes. These districts 
sometimes coincide with the areas of municipali- 
ties, and sometimes include parts of several mimi- 
cipalities. The issuing of the obligations for the 
financing of a local improvement of this character 
is usually authorized at a special election. At 
this election, a stated majority of the voters living 
in a certain locality which is to be benefited by 
particiilar improvements, such, for instance, as 
the regrading of certain streets in Seattle, or the 
construction of a levee in Louisiana, must signify 
their willingness to pay special taxes which are 
to be levied on the property benefited. 

The improvement will increase the value of the 
property. The owners of the property are willing 
to pay the cost of the improvement, and the fund 
to pay the cost will be created by the improvement 
which, if wisely planned and properly made, 
should increase the value of the property far more 
than the amoimt of the incumbrance placed upon 
it by the bond issue. These special tax-district 

bonds are considered apart from the municipal 

112 



HIGH-YIELD MUNICIPAL BONDS 

debts of the town, a part or all of whose area may 
be included in the tax district. The burden is 
borne, not by all the tax-payers, but by a partic- 
ular group of tax-payers. 

The usual remedy provided in case of default 
on special assessment bonds is the same as that 
provided for the collection of municipal bonds 
proper. For example, in Kansas, the holder of 
improvement bonds, for which the law provides 
special assessments against adjacent property, is 
entitled to mandamus, ordering a general tax 
levy to pay his judgment, and the city can then 
reimburse itself by levying assessments upon the 
property affected. 

Special assessment bonds are sometimes given 
special security. In Illinois, for example, bridge 
districts issue bonds which are a direct lien on the 
property of the district. On the bond, before it 
can be negotiated, the owner of each piece of 
property must place this endorsement, and his 
agreement that the property shall become liable 
for the interest and principal of the obligation, 
and that the bonds shall be a lien upon the prop- 
erty tmtil it is paid off and discharged. 

The issue of tax-district bonds is a method of 
evading the law which limits the borrowing power 
8 113 



THE CAREFUL INVESTOR 

of municipalities. It is equally certain, however, 
that in view of the conservatism of American 
legislative bodies on the subject of mimicipal 
debts, the special dispensations given to dis- 
tricts who borrow money for public improvements 
'are not likely to be abused. In neariy all cases, 
these special assessment bonds are sold to obtain 
money for public improvements which will greatly 
increase the value of the property affected. A 
final argimient in their favor is that this property 
is specifically liable for the repayment of the bonds. 
We may conclude, therefore, that in the bonds 
of tax districts there is offered to the investor 
an obligation which combines the advantages of 
high yield and good sectuity, security which is, 
on the whole, better than can be furnished him by 
most private corporations. With the continued 
development of the newer sections of the United 
States, these tax-district bonds will come upon 
the market in increasing volume. A study of the 
advantages which they offer will repay the investor 
who wishes to combine seciirity and high return. 



IX 
THE AMERICAN RAILWAY INDUSTRY 

Greatest of all sources of investment is the 
American Railway. For forty years the transpor- 
tation companies of the United States have poured 
into the world's investment-market a flood of 
securities. The savings of Europe and America 
have found their largest single outlet in railway 
stocks and bonds. The voltmie of railway securi- 
ties now outstanding presents a vast total. Of 
railway stocks there were outstanding at the close 
of 191 1, $8,582,000,000; of railway bonds, $10,- 
091,000,000. This svun is more than twice the 
national debts of the entire civilized world. It is 
the largest single contribution to the world's 
savings. If we except the value of land, it exceeds, 
in size and value, all other forms of investment 
in the United States combined. 

Of recent years, railway investments have de- 
clined in favor. Other bonds and stocks have 
entered the competition. Public hostility has been 
aroused against the railways. They have been 

subjected to severe regulation, denied the right 

115 



THE CAREFUL INVESTOR 

to advance their rates, in many cases forced to 
reduce them. Long enjoying a monopoly of the 
investment market, railway directors have hesi- 
tated to meet the demand for high-interest bonds. 
They have halted and hesitated, postponing the 
inevitable surrender to the demand for securities 
paying more than four per cent. 

We have here an explanation of the decreasing 
output of railway securities in recent years, and 
this, in turn, explains the slow progress of railway 
construction during the same period. Observe the 
figures. From 1880 to 1890 our railway mileage 
increased from 93,262 to 166,703 ; from 1890 to 1900, 
although this was a period of panic and depression, 
drought and scanty harvests, the growth in mileage 
was 166,703 to 194,262. From 1900 to 1910, how- 
ever, a period of enormous growth in other lines of 
business, the railway system increased 48,845 miles. 
In 191 1 only 3,465 miles were constructed. 

This small growth in mileage does not mean that 
American railroads are standing still. During the 
last decade they have spent, measured by the 
increase in their liabilities, $6,719,000,000 upon the 
properties. The expenditure has, however, been 
rather devoted to improving facilities than to build- 
ing new lines. Immense timnels, the Pennsylvania 

116 



THE AMERICAN RAILWAY INDUSTRY 

and New York Central in New York, the North- 
western in Chicago ; costly projects of electrification, 
such as that carried through by the New Haven and 
Hartford ; replacement of wooden by steel equip- 
ment, and large additions to equipment, have en- 
gaged the capital available for railroad construction. 

In five years, from 1903 to 1907, 14,424 loco- 
motives and 536,942 freight and passenger cars 
were put into service. Each year's additions, 
moreover, are of larger locomotives, and cars of 
greater cost and capacity. Vast sums have also 
been spent on the purchase of costly city real 
estate required for larger terminal yards. Track 
elevation, installation of block-signals, reduction 
of grades, and elimination of curves, have all 
taken substantial shares of railway funds. 

The American railway industry, considering its 
size, and the large number of companies operating it, 
is the soimdest and strongest business in the world. 
Observe, first, the size of the plant and personnel : 
mileage, 359,000; cars, 2,408,589; locomotives, 
65,310; employees, 1,699,420. Over 10,000,000 
Americans draw their living from the railroads. 

The business which is conducted by this great 

organization is worthy of it. In 191 2 American 

railroads transported 1,817,562,049 tons of freight 

117 



THE CAREFUL INVESTOR 

and 1,019,658,605 passengers. Expressed on a 

mileage basis, these figures are even more striking. 

Over every mile of American railroad in 1 910 were 

carried 1,071,086 tons of freight and 138,169 

passengers. This immense business was done, 

moreover, at a very moderate cost to the shipper 

and passenger, a fact proven by an average freight 

rate of .748 cents per ton per mile and a passenger 

rate of 2.22 cents per passenger per mile. No 

other industry, moreover, performs its service or 

furnishes its goods at so small a margin of profit. 

In the opinion of the best informed railway men, 

the passenger business is operated without profit ; 

and out of the three-fourths of a cent received for 

each ton carried one mile, it is a safe estimate that 

not more than one-fourth of a cent represents profit. 

In spite of these small profits on each unit of 

business handled, the railway industry is highly 

profitable, owing to the great volume of the traffic. 

For the year ending December 31, 191 1, the total 

profits of 246,655 miles of railroad operated were 

$1,085,951,595, or, deducting taxes, $972,237,934. 

The railway industry, on a gross business of about 

three billion dollars ($2,848,468,965), makes a 

profit of nearly one billion dollars. A business 

which can show one dollar in three as profit over 

118 



THE AMERICAN RAILWAY INDUSTRY 

the cost of operation is properly characterized as 
the most profitable business in the United States. 
Even the United States Steel Corporation, gen- 
erally recognized as the most profitable of the 
large industrials, now that the Standard Oil and 
American Tobacco Companies have been dissolved, 
in its best year, 1907, on a gross business of $757, - 
014,767.68 showed $177,201,561 of profits. 

And this introduces us to the second character- 
istic of the railway industry which especially 
recommends railway securities to the investor. 
Not only is the railway business profitable, but 
its prosperity is continuous, and its profits are, 
therefore, subject to smaller fluctuations. In 1908, 
the year following one of the severest panics in 
our history, railway profits declined only 6.2 per 
cent., and in 1909 they more than regained the loss. 
In good times and in bad, railway profits not only 
hold their own, but tend strongly to advance. 

The reason for this movement of profits it is 
important to understand. Profits of a business de- 
pend primarily upon the demand for its products. 
If that demand is sporadic and intermittent, the 
business will be, as Andrew Carnegie said of steel, 
either "a prince or a pauper.** But if the demand 
is continuous, fluctuating within narrow limits, 

119 



THE CAREFUL INVESTOR 

always tending upward, and if the business shows 
a large margin over cost of operation, we have, 
from the investor's standpoint, an ideal situation. 
Such a condition prevails in the railway world. 

The advantage of the railway industry from the 
standpoint of stability of profits is well illustrated 
by a comparison of the gross earnings of the 
Pennsylvania Railroad with those of the United 
States Steel Corporation. The one is the largest 
railroad system of the United States and one of 
the best managed, and the other is the largest and 
one of the best managed and best organized in- 
dustries. The steel corporation, moreover, manu- 
factures a great variety of products, so that its 
demand would naturally be more stable than those 
of steel manufacturing companies whose profits 
are more narrowly specialized. It has also been 
able to maintain, for long periods, stable prices 
for most of its products, and its supremacy in the 
steel trade since its organization has only recently 
been challenged. Competition, until the winter 
of 1909, very slightly disturbed it, and yet the 
fluctuation of its gross earnings, compared with 
the Pennsylvania Railroad, which appears in the 
following table, where the figures are stated in 

millions of doUars, is extreme. The figures for the 

120 



THE AMERICAN RAILWAY INDUSTRY 

Pennsylvania Railroad are as follows, stated in 

millions of dollars : 

1902 112 

1903 122 

1904 118 

1905 133 

1906 148 

1907 164 

1908 136 

and for the United States Steel Corporation as 

follows : 

1902 500 

1903 536 

1904 444 

1905 585 

1906 696 

1907 757 

1908 482 

The percentages of fluctuations from one year 
to another in the two companies are as follows : 

Pennsylvania U. S. Steel 

Railroad Corporation. 

1902 15.15 

1903 +8.93 +7.20 

1904 —3.28 —17.16 

1905 +12-71 +31 • 76 

1906 +11.28 +18.97 

1907 +10.81 +8.76 

1908 -17.08 -36.33 

Broadly speaking, the distinction which has 

been indicated between railway and manufacturing 

industries holds good wherever it is applied. The 

121 



THE CAREFUL INVESTOR 

demand for transportation services offered by some 
railways, especially those which depend exclusively 
upon iron and steel or kindred industries, is more 
irregular than those of some manufacturing com- 
panies — for example, gas or electric lighting com- 
panies or companies supplying certain food pro- 
ducts which are regarded as necessaries of life. 
But as between the two classes of corporations, 
railroads and industrials, the railway has a marked 
advantage in the greater stability of the demand 
for its service. 

The railway industry is also distinguished by 
its comparative freedom from competition. What 
manufacturing industry has vainly tried to accom- 
plish by unlawful combination, the railroads have 
achieved without conscious effort, solely by virtue 
of their economic position. The cost of duplicating 
their plant is so great as to protect them in the 
enjoyment of the traffic of which they have gained 
control. 

From every standpoint, the investor is correct 
in the marked preference which he has always 
shown in favor of railway securities. We turn 
next to consider certain weaknesses in the rail- 
road's position which arise out of its position as 
a public servant. 

122 



RAILWAY LABOR AND RAILWAY 
INVESTMENT 

The most important problem before the Ameri- 
can people is the problem of railway development. 
America is still an undeveloped coimtry. Three- 
fourths of the United States, industrially consid- 
ered, lies north of the Ohio and east of the Missis- 
sippi River. The West and South are yet in the 
infancy of their business development. 

The realization of the immense possibiHties of 
this country must depend upon the extension and 
development of our railroad facilities. It has been 
estimated by men whose opinions carry great 
weight, that at least one billion dollars each year 
for many years to come should be spent in rail- 
road building and rebuilding. Some of this new 
construction will be immediately profitable. On 
the largest part, the profits will be deferred. That 
vast expenditure which is demanded by considera- 
tion of public safety and convenience may never be 
profitable. 

In recent years, railway construction has lagged 

123 



THE CAREFUL INVESTOR 

behind the progress of other industries. A present 
indication of this fact is the impending shortage 
of railway equipment. A business revival has 
just begun, and already the inadequacy of the 
transportation system to carry the expected in- 
crease in trafHc is conceded. 

The railroads are unprepared, not because they 
have not foreseen the return of good times, but 
because of certain factors in the situation which 
make directors hesitate to invest great simis of 
money, even when the condition of their credit 
permits great stuns of money to be raised. 

This feeling of doubt and distrust of the future, 
which is everywhere encountered among railway 
officials and financiers, is due, first, to the apparent 
determination of the Interstate Commerce Com- 
mission not to allow any general advance in rates, 
and, second, to the increasing pressiu-e of the 
Railway Brotherhoods for higher wages. 

If railway expenses are not increased, the present 
scale of rates will yield satisfactory profits. But, 
from the attitude of railway labor, railway ex- 
penses will increase. The annoimced determina- 
tion of the railway labor organizations to increase 
the wages of their members is, from the stand- 
point of the railway and of the cotmtry, of far 

124 



RAILWAY LABOR AND INVESTMENT 

more serious import than the imyielding attitude 
of the Commerce Commission. 

It is a trite saying but a true one, that transpor- 
tation is the Hfe-blood of commerce. The special- 
ization of different regions to those industries in 
which, from the character of the population, their 
natural resources, or their proximity to markets, 
they have peculiar advantages has been carried 
so far in this country that free and continuous 
interchange of commodities is indispensable, not 
only to industry, but to existence. Suspend the 
operation of the railroads of the United States for 
one week, and the resulting damage would be 
almost incalculable. It would be measured not 
in money and in goods alone, but in human suffer- 
ing and human life. How many cities in this 
country are provisioned for one week? How long 
would the supply of fuel and material for the mills 
and factories suffice, if fresh supplies were inter- 
rupted? The answers to these questions are fur- 
nished by every snow-storm which ties up the 
railroads of a section even for a few days. Every 
business in the region feels the effect. The whole 
population suffers inconvenience, and the business 
losses are heavy. 

How much more serious would be the effect of 
125 



THE CAREFUL INVESTOR 

a general and a protracted suspension of railroad 
transportation. It would be a national calamity 
comparable to the effects of war or pestilence, a 
catastrophe which it is almost imthinkable that 
any body of men, for their own ends, however 
worthy and reasonable those ends might be, would 
combine to bring upon the coimtry ; or, to look at 
the matter from another standpoint, it is even 
more unthinkable that the responsible heads of 
the railway companies would allow a general sus- 
pension of railway operation to take place if the 
most extreme concession on their part could 
prevent. 

Into this situation of absolute dependence upon 
the continuous operation of the railroads, a situa- 
tion fraught with the possibilities of national 
disaster, enter the Brotherhoods with their peri- 
odical demands for increases in wages, reduction 
in hours, and more favorable conditions of employ- 
ment. 

One set of these demands made by the Brother- 
hood of Trainmen is now being considered by the 
Trtmk Lines. The Firemen and Engineers have 
recently gained important concessions from arbi- 
tration boards. As soon as this difficulty is settled, 
and from past experience a portion at least of the 

126 



RAILWAY LABOR AND INVESTMENT 

demands of the iinion will be granted, the never- 
ending controversy will be transferred to some 
other section or some other organization. The 
pressure of the imions upon the railroads is 
increasing and unceasing. 

In these discussions and contests, organized 
railway labor possesses a predominant advantage. 
They know just how valuable their services are. 
They know that the trains must run, and that no 
men outside their organizations can run them. 
Consider for a moment the extent of their advan- 
tage by comparison with labor contests in other 
fields. If the anthracite miners strike, the country 
suffers, but there are ways of escape for the con- 
sumer. We can turn to bituminous coal or gas, 
and there are reserves of anthracite to draw upon. 
If the bituminous miners strike, the users of 
bituminous coal can live for a time on their own 
reserves, or they can change their grates to bum 
anthracite. The last great strike in the iron and 
steel industry had little more than a local signifi- 
cance and effect. 

Let the railroad men strike, however, and, as 

1877 and 1894 showed, the entire country feels 

the blow. Every class, every commimity, every 

business, is affected. The four Railway Brother- 

127 



THE CAREFUL INVESTOR 

hoods hold in their hands the prosperity of the 
United States. Because they possess a monopoly 
of the skilled labor necessary to conduct the busi- 
ness of transportation, they have the power to 
cripple every business in the country. Skilled 
railway operators cannot be replaced by non-union 
men. For locomotive engineers or firemen there 
are few substitutes. If they cease to labor, the 
trains cease to move, commerce comes to a stand- 
still, factories close, business staggers and stops. 
The effect of the suspension of cash payments by 
the banks in 1907 is still remembered. The situa- 
tion at that time gave but a faint indication of the 
damage which the coimtry would sustain by the 
suspension of the railroads. 

Railway managers know this. Railway em- 
ployees know this. In every controversy over 
wages, hours of employment, or working condi- 
tions, the unique position of the railway, as an 
indispensable public servant, and the extraordi- 
narily powerful position of the employee of that 
public servant, are present in the minds of the 
contestants. Such a contest is tmequal. The men 
have all the advantage. They can throw the rail- 
roads into bankruptcy and the country into ruin, 

and they know it. They know further that the 

128 



RAILWAY LABOR. AND INVESTMENT 

railway managers will not be allowed by public 
opinion, even if their own dispositions set in this 
direction, to force the issue. They must make 
concessions; they must, in every contest, yield 
something. All, therefore, that is required is for 
the men to return again, and yet again, with ever- 
increasing demands, and they can obtain the entire 
surplus revenue of the railroad. 

I do not claim that the railway employees will 
carry their demands to this extent, or that the 
desire to confiscate the dividends of the railway 
stock-holders has ever entered the minds of their 
leaders. They have it in their power, however, 
to advance their wages to the point where the 
present scale of dividends can no longer be main- 
tained. When Lord Clive, on his return from 
India, was accused in the House of Commons of 
the practice of extortion, he replied, "Sir, when I 
think what I might have taken, I am astonished 
at my own moderation." With equal justice, the 
Railway Brotherhoods can point to the evidence 
of their moderation in the fact that the railroads 
can still pay dividends and lay aside something for 
their surplus accotmts. 

This situation is, however, fraught with possi- 
bilities of peril. So far as the Interstate Commerce 
9 129 



THE CAREFUL INVESTOR 

Commission is concerned, the railroads have little 
to fear. If the Commission will not sanction a 
general advance in rates, it is imlikely that it will 
order their general reduction. Railway rates, the 
products of innumerable adjustments and com- 
promises, tend constantly to stability. Each year 
the difficulty of change, because of the wider- 
reaching consequences of change, becomes greater. 
Adjustments between localities and classes of 
traffic, reductions in special cases, may be made; 
but the danger of a general reduction in rates 
which shall affect earnings is slight. 

It is not so with the labor situation. Here the 
representatives of organized labor have set no 
limit to their demands, short of the utmost ability 
of the railroads to pay. Railway wages, in their 
opinion, will never be high enough. They are 
willing to endorse the railroads' demands for 
higher rates, out of which higher wages might be 
paid, and, in fact, this proposition has been seri- 
ously advanced by some of their leaders. They 
will not, however, concede that railway wages can 
be limited, that, for example, the locomotive engi- 
neer should be restricted to a maximum of $80 
per month, a salary upon which he can purchase 

his house and send his children to the high school. 

130 



RAILWAY LABOR AND INVESTMENT 

They desire that his wages should rise to $250 
per month, upon which he can send his children 
to college. No matter how high railway wages go, 
they are still too low, in the opinion of the railway 
employee, for his necessities, his responsibilities 
and his deserts. 

And, after all, if only these demands can be 
reconciled with the necessities of the country for 
a full development of its resources, and with the 
just claims of the railroad stock-holders and credi- 
tors, why should the railway employee be denied 
his wish to rise to a higher plane of existence? 
Every day millions of people trust their lives to 
the men who run the trains, walk the tracks, and 
operate the signals and switches. What compen- 
sation will be considered too much for the faithful 
performance of this trust? What public servant 
has a more responsible position than the locomo- 
tive engineer ? Who has charge of a larger amount 
of property? Upon whose competence and vigil- 
ance depend so large a nimiber of human Hves? 

Let us come to the issue of the question : How 
can the demands of the railway men be met; 
demands which they apparently have present 
power to enforce; however gradually, with what- 
ever degree of conservatism they go about en- 

131 



THE CAREFUL INVESTOR 

forcing them ; while at the same time the needs of 
the coimtry for additional capital may be satis- 
fied ? Under present conditions, the profits of the 
railroads, present and prospective, large though 
they are, are not large enough to induce a sufficient 
amount of investment to meet the national require- 
ments. The coimtry has had abim.dant proof that 
in recent years sufficient money has not been spent 
upon railway facilities. Unless the outlook for 
railway profits becomes more favorable, these 
facilities will become increasingly inadequate. 

What, then, is to be done? Shall rates be ad- 
vanced to permit the payment of higher wages? 
How will this mend matters? If rates go up and 
wages rise with them, shippers and consumers are 
burdened and railway credit is not improved. It 
is by following no such vicious circle that the solu- 
tion of the problem is to be foimd. The United 
States will never reach a permanent solution of its 
transportation problem until railway labor can 
be brought to reahze and recognize by its acts 
that the railroads are entitled — ^in the words of 
the Supreme Court — "To a reasonable retiun 
upon a fair value of their property employed in 
the public service." This reasonable retiim is not 

to be the rate of interest on the best first mort- 

132 



RAILWAY LABOR AND INVESTMENT 

gages; but such a rate of profit, averaging good 
years with bad, as will attract capital into rail- 
road securities. More than this the railroad stock- 
holder does not and should not claim; less than 
this means an arrested railway development, a 
slow and halting industrial development, a condi- 
tion of prolonged business stagnation, broken only 
by fitful gleams of temporary prosperity. 



XI 

*'A REASONABLE RETURN UPON THE 

VALUE OF THE PROPERTY DEVOTED 

TO THE PUBLIC SERVICE" 

In the words which form the title to this Chap- 
ter, Mr. Charles A. Prouty, speaking for the 
Interstate Commerce Commission, on February 22, 
191 1, stated the problem presented to the Commis- 
sion by the petition of the Trunk Lines that they 
should be allowed to advance their rates. "We are 
to determine," said the Commission, "whether the 
net return of these carriers upon the value of their 
property devoted to the public service will be 
sufficient without an advance in their rates." 

After an exhaustive review of the testimony 
presented on behalf of and against the railroads, 
the Commission reached the conclusion that these 
defendants have not established such a need for 
additional revenue as justifies, at this time, an 
increase in these rates. This decision was, how- 
ever, without prejudice to the railroads. 

It has been several times stated in the course of this discussion 
that in view of the complex character of this problem, nothing 
but an actual test can satisfactorily determine the financial re- 

134 



A REASONABLE RETURN 

suits from the operations of these several carriers. There is no 
evidence before us which establishes the necessity for higher rates. 
The probability is that increased rates will not be necessary in 
the future. In view of the liberal returns received by these 
defendants in the past ten years, they should be required to show, 
with reasonable certainty, the necessity before the increase is 
allowed. If actual results should demonstrate that our forecast 
of the future is wrong, there might be ground for asking a further 
consideration of this subject. 

The railroads have again petitioned to be al- 
lowed to make a five per cent, advance in all rates 
in Official Classification Territory, north of the 
Ohio and east of the Mississippi rivers, an advance 
equivalent to a $40,000,000 increase in net rev- 
enues. If their officials were not convinced that 
the "actual test'* asked for by the Commission 
had demonstrated that the Commission was wrong, 
the railroads would not make attempt to increase 
their rates. What, then, is the nature of this 
experience of the last three years, upon which the 
railroads must rely if they are to induce the Com- 
mission to reconsider its decision of 191 1 ? 

This question must be answered with reference 
to the evidence and reasoning upon which the 
Commission's former refusal was based. In sub- 
stance this was as follows: The Pennsylvania, 
Baltimore and Ohio, and New York Central are 

typical tnmk-line railroads. Their freight rev- 

135 



THE CAREFUL INVESTOR 

enues were nearly one-half of the total freight 
revenue in Official Classification Territory. 
"Whatever rate might reasonably be imposed upon 
these three systems must be held to be a reason- 
able charge for that service by all lines." 

The Commission defined a reasonable return 
upon the property of these three companies to be 
a margin of profits equivalent to certain earnings 
upon their common stocks. For the Baltimore 
and Ohio, it was held that **the sum remaining 
after fixed charges, including as a fixed charge the 
dividend upon the preferred stock, should be 
equivalent to between 7 and 8 per cent, upon the 
common stock," or about $2,280,000 — 1>^ per 
cent, on the present common stock. For the 
Pennsylvania, a margin of $18,000,000 over com- 
mon-stock dividends was held not to be unreason- 
able. For the New York Central, the Commission 
fotmd that, after allowing for an expected increase 
in operating expenses due to the higher wage scale 
which went into effect in 1910, the Company could 
pay its 6 per cent, dividends with about $1,500,000 
to spare. For several reasons; an admitted infla- 
tion of the capital of the constituent companies and 
of the New York Central at the time of the consoli- 
dation in 1869, amounting to $57,000,000, on which 

136 



A REASONABLE RETURN 

stock issued without consideration to the company, 
$120,000,000 in dividends had been paid, and not 
omitting to mention the fact that the New York 
Central was burdened with unprofitable leases, 
losses on which the public should not be expected to 
make up to its stockholders in higher rates, and 
having regard, finally, to the exceptionally strong 
position of certain of the New York CentraFs sub- 
sidiaries, the Commission reached the conclusion 
that this margin of $1,500,000 over the dividend 
requirement was not so small as to warrant an 
increase of freight rates in order to increase it. 

We have, then, this standard by which to deter- 
mine the reasonableness of rates in Official Classi- 
fication Territory. If it appears that existing rates 
now yield these three companies substantially less 
than the amoimt of profits which the Interstate 
Commerce Commission, in 191 1, declared to be 
reasonable, then the carriers will have established 
their case. If, on the other hand, the dividends 
of these three typical companies, notwithstanding 
higher operating costs and increased fixed charges, 
are still protected by the same relative margins of 
safety as those which the Commission considered 
adequate in 191 1, then the railroads have lost 

their case before they open it. 

137 



THE CAREFUL INVESTOR 

The facts of railway profits for the last year for 
which statistics are available are as follows for 
each of the three companies under examination : 

Pennsylvania Railroad Company — Year Ending December 31, 
1912: 

Net Income $42,153,964 

Dividends 6 per cent 27,198,918 

Balance $14,955,046 

Baltimore and Ohio — ^Year Ending June 30, 1912: 
Balance of Net Income or for Preferred Divi- 
dends $11,543,000 

Dividends on common 6 per cent 9,121,073 

Balance $ 2,421,927 

New York Central and Hudson River Railroad — ^Year Ending 
December 31, 1912: 

Balance of Net Income over all charges $13,879,837 

Dividends (5 per cent.) 11,136,465 

Balance $ 2,743,372 

Amoimt required to pay 6 per cent., the stand- 
ard accepted by the Commission in 1911 . . $13,563,558 
Balance — over 6 per cent 316,279 

Simimarized, these results are as follows : 

Balance of Net Earnings over charges accepted by the Commis- 
sion as standard in 191 1 : 

Baltimore and Ohio $ 2,280,000 

Pennsylvania 18,000,000 

New York Central 1,500,000 

Balance of Net Earnings over charges for last fiscal year: 

Baltimore and Ohio $ 2,421,927 

Pennsylvania i4.955.9iS 

New York Central 316,279 

138 



A REASONABLE RETURN 

From these figures it appears that, measured 
by the standard accepted by the Interstate Com- 
merce Commission, the Baltimore and Ohio is in 
about the same relative position as in 1910, the 
New York Central has suffered a severe decline 
in its margin of safety, and the margin of safety 
of the Pennsylvania has seriously decreased. 

On the basis of the Commission's reasoning in 
191 1, and taking no account of changes in condi- 
tions affecting the railroads since that time, the car- 
riers are evidently entitled to an increase in rates. 

It is also possible to advance additional argu- 
ments in support of the railroad's contention, 
based on alleged changes in conditions affecting 
the railroads since 1910. 

Operating expenses have rapidly increased, out- 
stripping the substantial gains in gross earnings. 
For this the demands of organized labor are mainly 
responsible and these show no signs of abatement. 

The investment situation is not satisfactory. 
Weak companies are continually facing financial dif- 
ficulties. Some companies, hitherto reported strong, 
have been shown to be extremely weak. Many strong 
companies are turning from one emergency expe- 
dient to another in the attempt to finance their ma- 
turing obligations. Railroads must apparently pay 

139 



THE CAREFUL INVESTOR 

five per cent, for money, and until the international 
financial situation clears, they may have difficulty 
in filling their requirements, even at that high figure. 

Public regulation is, moreover, growing more 
exacting. Greater safety in travel, improved 
working conditions and shorter hours for em- 
ployes, the provision of improved facilities for 
shippers, such regulations are becoming universal, 
and each one adds to the cost of railway opera- 
tion. The railroads have suffered, in common 
with all industries, from the rising prices of their 
operating supplies, of which coal is the most im- 
portant. Their costs of construction and repair 
have also greatly increased for the same reason. 

On the other hand, it is possible to advance 
some considerations on behalf of the shippers and 
against the increase of rates. The method fol- 
lowed by the Interstate Commerce Commission 
takes accoimt only of the profits of companies, dis- 
regarding the profits of groups of companies. Back 
of the New York Central, for example, is a group of 
wealthy and prosperous subsidiaries, which have 
earned far more than they have paid to the parent 
company in dividends. The same is true of the 
Pennsylvania. Again, the present stringency in the 

investment market is not permanent. Railway se- 

140 



A REASONABLE RETURN 

curities will improve in market and price, especially 
after the companies, as the Pennsylvania is now 
doing, have reorganized their capital accoimts by 
creating general refunding mortgages under which 
bonds of a kind acceptable to investors can be sold. 

It has not been shown that railway efficiency has 
reached the practicable maximimi. Indeed recent 
investigations of the New Haven and Hartford 
show that efficiency can be largely increased. 

Finally, it does not appear that the railroads 
would be allowed to retain the $40,000,000 which 
is the estimated amoimt of the yield from the in- 
crease in rates in Official Classification Territory. 
Railway labor is not yet satisfied, and assess- 
ments upon railway property are steadily advanc- 
ing. The final result might be that the shipper has 
made a substantial contribution, not to the rail- 
roads, but to the railway employes and to the State. 

Before the increase in rates is granted, the en- 
tire subject of the financial situation of the rail- 
roads will be carefully investigated by the Inter- 
state Commerce Commission. It is to be hoped 
that the result of this investigation will be the 
formation of some conclusions and standards of 
permanent value in the determination of what 

constitutes a reasonable railway rate. 

141 



XII 



THE SECURITIES OF PUBLIC-SERVICE 
CORPORATIONS 

/- 

The public-service corporation is so-called be- 
cause it supplies a service or a commodity to the 
entire population of a commimity. As an aid to 
the performance of this public service, it is allowed 
to occupy the public streets and other public prop- 
erty with pipes, wires, or tracks, imder a grant of 
authority from "^e municipaHty known as the 
franchise. Examples of public-service corporations 
are street-railway companies, telephone and tele- 
graph, gas, water, and lighting companies. Steam 
railroads, interurban electric railroads, and water- 
power companies are sometimes included in this 
classification. 

The securities of public-service corporations 
present desirable opportimities to the investor. 
Public-service corporations operate in industries 
which are very profitable, and whose profits are 
rapidly increasing. Furthermore, owing to the 
long-standing prejudice of the largest investors 
against these securities, a prejudice only recently 

142 



PUBLIC-SERVICE CORPORATIONS 

overcome, they can still be purchased at prices 
which yield between five and six per cent. 

It is important to tmderstand why the public- 
service industries are so exceptionally prosperous. 
The fact must be admitted. In Philadelphia, for 
example, the underlying companies of the street- 
railway system pay extraordinary dividends. The 
Union Passenger Railway, for example, pays 19 per 
cent, on its stock, the Thirteenth and Fifteenth 
Passenger Railway 24 per cent., and the Frank- 
ford and South wark 34 per cent. These are the 
original underlying companies. While an enor- 
mous investment has been made in their property 
by each of the three companies which have suc- 
ceeded them in the development of the street- 
railway system of Philadelphia, yet the large 
dividends earned by the imderiying companies 
give a good idea of the profits of street-railway 
operation in a large city. The same may be said 
of gas, water, telephone, and electric light and 
power companies. In all large cities, these enter- 
prises are exceedingly profitable. 

This statement is made to refer to large cities 
because it is only in the large city that the opera- 
tion of the law of increasing returns in public- 
service industry has reached its full development. 

143 



THE CAREFUL INVESTOR 

In small cities and towns, public-service industries 
are no more prosperous than any other. 

The operation of the law of increasing returns 
may be illustrated from the street-railway indus- 
try. Street-railway operation involves the main- 
tenance of regular and frequent schedules for the 
service of the public. It costs but little more to 
operate a full car than a car half full or empty. 
Up to the capacity of the tracks in the congested 
districts, and up to the generating capacity in the 
power-houses, additional cars may be added to 
accommodate the increase of traffic with a com- 
paratively small increase in the expense. 

The operating expenses of every business include 
certain items which are comparatively fixed, and 
certain other items which increase and diminish 
with the voltmie of business. A street-railway 
corporation, for example, makes a certain invest- 
ment in tracks, overhead work, power houses, car- 
bams, equipment, and cars. Out of the revenues 
from the operation of this property, it must earn 
enough to pay interest on its plant, to keep it in 
repair, and to provide for its replacement when it 
is worn out. It must also buy fuel and other 
supplies, and employ a large ntmiber of men in 
operating its power-house and in keeping its plant 

144 



PUBLIC-SERVICE CORPORATIONS 

in repair. It has an expensive executive and legal 
staff. It employs, if located in a large city, several 
thousand motormen and conductors. Out of every 
five cents v/hich the passenger pays, provision 
must be made for all of these charges — so much for 
interest, for depreciation, for maintenance, and 
for operation of the cars. 

The larger the number of people transported by 
this plant within a given time, the smaller will be 
the share of these total expenses which must 
be borne by each passenger, and the larger will 
be the fraction of the five-cent fare which will 
remain to the company as its profit. Up to the 
capacity of its plant, in other words, each addi- 
tional thousand passengers transported by the 
street-railway company means a division of the 
total operating expenses among a larger nimiber 
of riders, and an increase in the profit which the 
company takes out of each nickel which the pas- 
sengers pay. 

When the capacity of the plant has been reached, 

and it becomes necessary to supplement surface 

street-railway lines costing $60,000 per mile, with 

elevated lines costing $500,000 per mile, or subway 

tunnels costing $2,000,000 per mile, then the profits 

are by no means so great, because the fixed charges 
10 145 



THE CAREFUL INVESTOR 

have been enormously increased. As soon as this 
replacement has been made, however, and the 
traffic, in response to the improved faciHties, begins 
again to increase, the law of increasing returns 
again comes into operation, and up to the capacity 
of the new and enlarged plant, each additional 
thousand passengers means an increase in the 
margin of profit in each passenger's fare. 

The same law controls the expenses and profits 
of gas, water, and lighting companies. As the 
population which they serve increases, and the 
volume of their business grows, it has been foimd 
that they can supply this increased demand for 
long periods without materially increasing their 
plant, and with comparatively sHght increases in 
operating expenses. 

Another feature of the demand for the commod- 
ities or service furnished by public-service cor- 
porations is that not only does it increase with 
the growth of population, but that it increases 
faster than the population grows. The reason for 
this can be readily understood in the case of the 
street railway. As the population of a city grows, 
land values and rentals in the downtown sections 
rapidly increase. Population, both because of the 

lower rents in the suburbs, and also because of 

146 



PUBLIC-SERVICE CORPORATIONS 

the cheapness and convenience of transportation 
which the street railway furnishes, moves from the 
central sections to the outlying sections. This 
means that a great number of people Hve several 
miles from their work, to which they must go six 
mornings a week, and from which, six evenings a 
week, they must return. The larger the poptila- 
tion grows, the larger becomes this movement to 
the outlying sections and the stronger the demand 
for transportation. The central portion of the 
city is the nattiral location for the large depart- 
ment stores, hotels, theatres, and street-railway 
terminals. These draw in multitudes of people 
over the street-railway lines. 

The same proportionately greater increase in 
demand, as compared with the growth in poptda- 
tion, is seen in the gas industry. From 1890 to 
1 9 10, for example, the population of the four 
boroughs of New York city increased 90.6 per 
cent, but the consimiption of gas increased 164.6 
per cent., nearly double the increase in population. 
In this field, the increase in demand is due not 
only to the growth of population, but to the grow- 
ing usefulness of gas in industrial work, as well as 
for cooking, heating, and other domestic purposes. 

The business of furnishing light and power and 

147 



THE CAREFUL INVESTOR 

heat shows the same tendency. The investor in 
the securities of well managed public-service cor- 
porations that may be located in a city of at least 
100,000 popiilation can be reasonably certain that 
the city will grow, and that as it grows the prof- 
its of his company will increase at a more rapid 
rate. 

, Public-service corporations do not, as a nile, 
divide their earnings with competitors. Even 
when the city does not give them the exclusive 
right to supply transportation — and the policy of 
our law is opposed to exclusive grants of this 
character — the favorable conditions tmder which 
their business is carried on give them a practical 
monopoly. The nature of this monopoly, as well 
as the advantages of an investment in a public- 
service corporation in a large city, was clearly ex- 
pressed by Mr. Justice Peckham of the United 
States Supreme Court in delivering the opinion 
of the court in the case of Wilcox vs. Consolidated 
Gas Company of New York as follows: 

In an investment in a gas company, such as complainants*, 
the risk is reduced almost to a minimum. It is a corporation, 
which in fact, as the court below remarks, monopolizes the gas 
service of the largest city in America, and is secure against com- 
petition under the circumstances in which it is placed, because 
it is a proposition almost unthinkable that the city of New York 

148 



PUBLIC-SERVICE CORPORATIONS 

would, for purposes of making competition, permit the streets of the 
city to be again torn up in order to allow the mains of another com- 
pany to he laid all through them to supply gas which the present 
company can adequately supply. And, so far as it is given us to 
look into the future, it seems as certain as anything of such a 
nature can be, that the demand for gas will increase, — and, at the 
reduced price, increase to a considerable extent. An interest in 
such a business is as near a safe and secure investment as can be 
imagined with regard to any private manufacturing business. . . 

In the absence of legal restrictions, a company 
possessing a monopoly of a necessity of life is 
limited in its charges only by what the traffic will 
bear. If the price of gas is too high, the consump- 
tion will fall off, and the expense of operation, 
reversing the process which was explained illus- 
trating the law of diminishing rettims, will be 
increased. Interest, taxes, maintenance, depre- 
ciation, executive expenses, advertising, etc., will 
be spread over a smaller amount of production, 
and the cost of each thousand feet produced will 
be correspondingly increased. 

It is to the interest of a monopoly to lower the 
price of its product so far as this lowering of the 
price will increase consimiption and increase 
profits. Below this point it is not to the interest 
of the monopoly to go. If, for example, a price of 
$i.oo per thousand feet will yield $6,000,000 of 
revenue, while a price of eighty cents will yield a 

149 



THE CAREFUL INVESTOR 

profit of only $5,500,000, because the consumption 
will not increase to correspond with the reduction 
in the price, the monopoly, imless constrained by 
law, will not make the reduction. On the other 
hand, if a reduction to eighty cents will so much 
increase the constimption as to raise the profits 
from $6,000,000 to $7,000,000, it is to the interest 
of the monopoly to reduce the price. Below the 
price at which the largest profit will be realized, 
a corporation having a monopoly of any commodity 
or service, will not willingly go. 

At this point, in the case of the public-service 
corporation, the State steps in and applies a 
principle of profit regulation which is as follows: 
A corporation operating in a public service in- 
dustry supplying a necessity of life to the com- 
mimity, is entitled to profits equal to a reasonable 
return on a fair value of its property which is 
employed in the public service. The fair value 
of property has been determined, as a result of a 
long series of judicial decisions, to be a combina- 
tion of the cost of reproducing and the fair market 
value of the property at the time the valuation 
is made. The "reasonable return'* depends on 
drcimistances. Again to quote from the Con- 
solidated Gas case: 

150 



PUBLIC-SERVICE CORPORATIONS 

There Is no particular rate of compensation which must in all 
cases and in all parts of the country be regarded as sufficient for 
capital invested in business enterprises. Such compensation 
must depend greatly upon circumstances and locality; among 
other things, the amount of risk in the business is a most impor- 
tant factor, as well as the locality where the business is conducted 
and the rate expected and usually realized there upon investments 
of a somewhat similar nature with regard to the risk attending 
them. There may be other matters which in some cases might 
also be properly taken into account in determining the rate 
which an investor might properly expect or hope to receive, and 
which he would be entitled to without legislative interference. 
The less risk, the less right to any unusual returns upon the 
investments. One who invests his money in a business of a some- 
what hazardous character is very properly held to have the right 
to a larger return without legislative interference, than can be 
obtained from an investment in Government bonds or other per- 
fectly safe security. The man that invested in gas stock in 1823 
had a right to look for and obtain, if possible, a much greater 
rate upon his investment than he who invested in such property 
in the city of New York years after the risk and danger involved 
had been almost entirely eliminated. 

In this case, the court found that since the gas 
business was probably the safest of manufacturing 
industries, since the Consolidated Gas Company 
possessed a monopoly, and since its future was 
reasonably assured, a return of 6 per cent, would 
be sufficient, and that a price of eighty cents per 
thousand feet for gas would yield this return. 

Starting at 6 per cent, as a "reasonable return" 

in the safest public-service corporation, we go up 

in the scale according to circumstances. For ex- 

151 



THE CAREFUL INVESTOR 

ample, the "reasonable return" for the Great 
Northern and Northern Pacific railroads in a 
recent court decision was held to be 7 per cent., 
and it is not to be doubted that whenever the 
matter comes before the courts for determination 
the rate which the public service corporations will 
be allowed to earn will be fixed according to the 
circumstances of the industry, and of the particular 
company in question. A 10 per cent, return 
might be reasonable for a street-railway company 
in a small city, while it would be exorbitant for a 
street railway in a metropolis. 

The development of this theory that the public- 
service corporation is entitled to no more than a 
"reasonable rate of return," while attended with 
serious misgiving on the part of bankers and in- 
vestors when it first came into active application, 
is now regarded as one of the greatest safeguards 
which the investor in these securities can have. 
The public-service corporation is by its nature a 
monopoly. If the company is properly capitalized, 
if the plant is properly constructed and managed, 
and if ordinary business judgment has been used^ 
in fitting the capacity of the plant to the demand 
for its product or service, the returns to the in- 
vestor are certain, because the law allows the 

152 



PUBLIC-SERVICE CORPORATIONS 

charging of rates which will yield a "reasonable 
return" on the capital invested. Of no other 
department of investment is this true. The inves- 
tor in mining securities, real-estate securities, 
industrial securities of all kinds, is not given any- 
thing by the law. He must take his chances. He 
has not the advantage of a monopoly. If, as the 
trusts attempted to do, these enterprises unite to 
obtain monopolistic power, the law is invoked 
against them, and these illegal combinations are 
broken up. The public-service corporation, how- 
ever, is a monopoly, and the law protects it in the 
enlargement of its monopolistic profits up to a 
point of a "reasonable return" which, as has been 
explained, is quite sufficient to satisfy the investor. 



XIII 

THE INVESTMENT-BANKER AND THE 
PUBLIC-UTILITY COMPANY 

Bonds of public-service corporations can fre- 
quently be bought to yield 5 to 5>^ per cent, to the 
investor. These high yields inspire caution. They 
raise a presumption against the issue. Cautious 
investors discriminate against high-yield bonds. 
High-interest rates and lower prices — are they not 
indications of lack of demand for these securities? 
And is not the explanation of this weaker demand a 
higher percentage of failures in this field than with 
the railroads? The investment-banker does not 
waste time in direct answers to these questions. 
He backs up his offerings of public-service bonds 
by detailed evidence of their worth, obtained by in- 
vestigation of every factor influencing their value. 

The first step in offering an issue of public- 
service company bonds, is to investigate the busi- 
ness basis of the proposition, which is found in the 
territory served. Only large cities or groups of 
small cities, united for all business piirposes, are 
considered by the best houses for direct offering. 

When gas, water, electric light, or transportation 

154 



THE PUBLIC-UTILITY COMPANY 

securities, issued by companies serving small towns, 
are offered, the usual method is to combine them 
under a collateral trust mortgage, so that a large 
issue of bonds, each with the same security, may be 
offered. I have before me a description of an issue 
of this character, $9,000,000 in amotmt, secured by 
twelve issues of bonds, sundry notes, and fourteen 
issues of stocks. These securities have a market 
value of about $22,000,000, and return more than 
three times the interest on the $9,000,000 bonds. 
Great difficulty would, however, be met in selling 
them separately, because of the limited market 
which would be open to each. The holding company, 
of which this is an illustration, is useful in making a 
market for securities of small companies, which 
would otherwise be unsalable at reasonable prices. 
The banker prefers, however, direct offerings 
of bonds secured not by the pledge of these pieces 
of paper issued by smaller companies, but by the 
pledge of property. So far as he is governed by 
this preference, he must confine his operations to 
the larger cities, for nowhere else can he find the 
conditions of perfect security and reasonable cer- 
tainty of appreciation in value which he desires. 
His offering is made stronger if the security in- 
cludes a large amount of surroimding territory, 

155 



THE CAREFUL INVESTOR 

but the foundation must be the dense and growing 
population of the city. Great importance is placed 
by the banker upon the growth of the city under 
examination, not only its past growth in popula- 
tion, but its future as a manufactiuing, railroad, 
and commercial centre. For example, note the 
following vital facts concerning Seattle, furnished 
in connection with a recent bond-offering. 

In 1880 the population of Seattle was 3,535; in 1890, 42,837; 
in 1900, 80,671. At present the estimated population is 265,000. 
From 1903 to 1907 the taxable valuation of the city rose from 
156,674,000 to $156,531,724, and bank clearings from $206,913,- 
000 to $488,591,000. During the past six years, the building 
permits have increased 300 per cent., and the value of real-estate 
transfers over 600 per cent. The Great Northern and the North- 
em Pacific Railway systems have terminals in Seattle, and the 
Canadian Pacific enters the city. The Chicago, Milwaukee and 
St. Paul is building to Seattle, and the Union Pacific is planning 
an entrance from the south. The harbor is excellent. The aggre- 
gate commerce of the port in 1907 was $140,472,821. The trade 
with the Orient and with Alaska, already large, is rapidly increas- 
ing. Seattle is 600 miles nearer Yokohama than San Francisco, 
and the natiiral gateway for Alaskan trade. Ntmierous industries 
are established in the city, which has become undoubtedly the 
most important business and distributing centre on the North 
Pacific Coast, and, in fact, one of the great cities of the country. 

When such statements can be made concerning 

a city, and if other conditions affecting seciuity 

can be satisfactorily met, bonds secin-ed by a Hen 

on its public-service corporation property are as 

safe as the best railroad bonds. 

156 



THE PUBLIC-UTILITY COMPANY 

Assuming that the business basis of the company 
is sound, the next step in the investigation is the 
engineer's examination. Every banking house of 
standing has engineering connections, and large 
sums are often paid for exhaustive reports. The 
engineer's examination covers the condition of the 
plant in reference to maintenance and operating 
efficiency; the quality of the management, espe- 
cially as to its demonstrated ability to cultivate 
amicable relations with the public; and the rates 
charged. If these rates are higher than those 
generally prevailing in the State, or higher than 
sufficient to yield a reasonable return upon the 
investment, they are likely to be reduced; and the 
bond-issue must be limited accordingly. The 
engineer also makes a careful appraisal of the cost 
of replacing the physical property of the company, 
since this sum represents the figiu-e on which the 
courts will always allow a reasonable return. The 
engineer often goes so far as to criticise the policy 
of the management, to suggest plans for improve- 
ment in service, and to point out ways in which the 
company's business can be expanded. His report 
is a document often hxmdreds of pages in length, 
which gives the banker a complete picture of the 
property and business which he is asked to finance. 

157 



THE CAREFUL INVESTOR 

Often, engineering firms, in order to secure con- 
stant employment for their organizations, bring 
propositions to the bankers as promoters, and go 
so far as to offer their cooperation in financing 
the undertaking. The tendency is now toward 
such cooperation between bankers and engineers. 
A proposition submitted by an engineering con- 
cern of standing in its field is sure of respectful 
and attentive consideration from the banker, who 
knows that the engineer's primary interest is not 
to take part in the financing, but to make his 
regular percentage of engineering profit. The engi- 
neer's interest may extend beyond the initial stages 
of a proposition. He may take charge, for a period, 
of operating a new concern, breaking in a perma- 
nent organization, and insuring economical and 
efficient management during the trying first years. 

Supplementing the engineer's investigation is 
the audit of the company's books. Banking houses 
usually employ their own auditors, although they 
often utilize the services of public accoimtants. 
The chief importance of the audit is to make sure 
that the company's accoimts have been properly 
kept. Many items can be charged to cost of con- 
struction which belong in cost of operation. A 

surplus may be created by placing upon such 

158 



THE PUBLIC-UTILITY COMPANY 

intangible items as "franchises" a high value 
which has no substantive basis. 

The accountant looks closely to the depreciation 
charge. As a recent writer on accountancy has 
well said, "All machinery is on an irresistible 
march to the junk-heap.'* Provision must be 
made out of current income, not only for necessary 
current replacements, but to provide against the 
day when a large part of the plant will have to be 
renewed. All this information is of the greatest 
interest and value to the banker. He wishes to 
present to his cHents such a statement as the 
following, and to know that it is accurate. 

EARNINGS 
(Certified by Messrs. Price, Waterhouse & Company, Chartered 

Accountants; and Allen Knight, Esq., C. P. A.) 
Year ended December 31: 1909. 1910. 1911. 

Gross Earnings $13,491,288 114,044,596 114,682,669 

Operating expenses, 
maintenance and 
taxes 7»53i.576 7.92i,34i 8,151,364 



NET EARNINGS... $ 5,959,712 $6,123,255 $6,531,305 
Bond interest paid 3,278,177 



Balance $ 3,253,128 

Gross earnings during the past five years have shown a steady 
increase, as follows: 

1907. X908. 1909. 1910. 1911. 

$11,342,140 $12,657,305 $13,491,288 $14,044,596 $14,682,669 

159 



THE CAREFUL INVESTOR 

When the banker can submit information of this 
character, his argiiment is convincing. 

The banker insists upon a large residual value 
in the property over the amoimt of the bond-issue. 
He does not propose to fimiish the money to 
construct his security. The larger this margin of 
value is, the safer are the bonds. One measure of 
equity is the market value of stocks, based on 
dividends paid. The banker is careful, however, 
to determine whether these dividends have been 
fully earned ; whether the market value upon which 
he, as the investor's representative, is asked to 
rely, represents the judgment of the investor or the 
hopes of the speculator. 

A far better guide to the value of the property 
is the cost of reproduction. That a public-service 
property has cost $5,000,000 is not conclusive 
evidence that it can earn interest on this simi. A 
large part of the money may have been wasted by 
careless, incompetent engineers, or the plant may 
be too large for the business to be obtained. As 
a rule, however, the standard of original cost, or 
cost of replacement, whichever is the lower, fur- 
nishes a safe guide to the "equity" or margin in 
the property, for the protection of the bonds. 

With this margin as a starting point, and with the 

160 



THE PUBLIC-UTILITY COMPANY 

assurance of good management, efficient operation, 
and the opportunity for the development of a 
large business, the banker has only one remaining 
consideration to examine — the franchise. 

In a preceding chapter I have shown that public- 
service companies operating in large cities were 
so-called natural monopolies, supplying necessities 
of life to increasing populations at diminishing costs 
of production and distribution, at prices restricted 
only by considerations of its own interest. These 
opportunities for large profit must, however, be 
enjoyed under the supervision of the State. Un- 
reasonable rates will not be permitted. The 
evidence of unreasonable rates is found in an 
imusually high percentage of earnings. If the 
corporation has an express franchise contract with 
the city, permitting it to charge a certain price or 
fare, it cannot be disturbed, no matter how great 
may be its profits. In the absence of such a 
stipulation, the company's earnings may at any 
time be reduced to what the courts consider a 
reasonable return, by a change in rates, fares, or 
prices. 

The banker must look closely into the franchise 

question. He must consider first the term. If 

the franchise is for 25 years, then the bonds which 
11 161 



THE CAREFUL INVESTOR 

he buys should mature within 25 years. The 
banker next considers the burdens imposed by the 
franchise upon the company, what payments — car 
licenses, street repairs, lighting, direct contribu- 
tion to the public treasury — does it impose, and 
finally, what are the provisions for extension at the 
expiration of the franchise? These questions are 
the most important asked by the banker concern- 
ing the terms on which the company, the purchase 
of whose bonds he is considering, will be allowed 
to do business during the life of the bonds. 

In recent years a solution of the franchise ques- 
tion has been attempted by the development of 
various plans of city partnership in public-service 
vmdertakings. The experiments of Chicago, Phila- 
delphia and New York in this direction we have 
now to consider. 



XIV 

THE PUBLIC-SERVICE CORPORATION 
AND THE CITY 

The last chapter outlined the examination which 
is made by the investment-banker when he is 
asked to purchase the securities of a public-service 
corporation. The conclusion was reached that the 
most important part of this examination concerns 
the franchise, the right of the company to do 
business. 

The foundation of investment is legal security. 
A corporation is created by the State, and is pro- 
tected by the power which creates it. It is given 
great privileges: the right to do business as a 
private individual or a partnership; the right to 
take private property at a fair valuation even 
against the will of its owners ; the right to occupy 
the public streets with tracks, pipes, and wires; 
and the right to a fair return on the money which 
its owners have contributed, or which it may have 
borrowed from creditors. 

Along with these rights, however, go certain 

obligations, often not clearly defined in charters 

163 



THE CAREFUL INVESTOR 

and franchise contracts, but more or less clearly- 
understood by all parties. These obligations are 
to give good service, to charge reasonable rates, 
to seek additional privileges only through legiti- 
mate channels, to recognize that a pubHc corpora- 
tion has a public duty to perform, and that the 
interests of the people are, in a sense, placed in its 
keeping. 

The case is perfectly plain. Here is an agree- 
ment to which the public and the public-service 
corporations are parties. The party of the first 
part gives certain privileges, special opporttmities 
for making money. The party of the second part, 
perhaps not expressly, but by plain implication, 
agrees to develop these privileges and opportunities 
in such a way as to benefit not merely themselves 
but the people from whom these advantages are 
derived. 

There is a widespread sentiment, only recently 
beginning to subside, that the public-service cor- 
porations have not lived up to their part of the 
agreement. It is claimed, and generally believed, 
that these valuable franchise privileges have been 
capitalized at excessive figures, and that imreason- 
able rates and prices have been charged to pay 

interest and dividends on this inflated capitali- 

164 



THE CITY 

zation. As a result of this heavy capitalization, 
which often takes the form of bonds or is repre- 
sented by leases at very high figures, it is claimed 
that the good service which should be rendered 
by the public-service corporation is frequently 
allowed to deteriorate. In other words, in order 
to pay interest, dividends, and rentals, the public 
is forced to stand in the street-cars, when a more 
moderate capitalization would allow a sufficient 
equipment to give each rider a seat. 

There was, no doubt, some ground for these 
criticisms, even though the statements on which 
they were based were in many cases greatly ex- 
aggerated and distorted. 

Within the last ten years the public came to 
believe that they were absolved from their implied 
promise to allow the public-service corporations a 
free hand in their business, since the public-service 
corporations had not kept their part of the agree- 
ment. The aid of the government was thereupon 
invoked to force what the people considered resti- 
tution. Taxes were laid upon franchises. The 
price of gas and telephone service was subjected 
to sudden and drastic reduction. Public senti- 
ment was invoked to refuse to extend franchise 

grants, and taxes on property were largely in- 

165 



THE CAREFUL INVESTOR 

creased. Restrictions, as, for example, in refer- 
ence to street cleaning and repair, or the placing 
of wires underground, were imposed. In many 
parts of the coimtry — Chicago, Cleveland, St. 
Louis, Detroit, Pittsburg, Philadelphia, and New 
York — this agitation against the public-service 
corporations broke out with great violence. The 
agitation resulted, for a time, in discrediting the 
securities of these companies. As a result several 
of these corporations were forced into bankruptcy. 
Others staggered along on the brink of insolvency. 
It was impossible to obtain the capital for neces- 
sary improvements and extensions in the face of 
hostile public opinion. The investor would have 
nothing to do with securities which were so badly 
tainted with tmpopularity. 

The situation became intolerable. On the one 
hand, the public was suffering from the lack of the 
facilities, particularly in the field of transporta- 
tion ; on the other hand, companies could not raise 
the money to provide these facilities. The people 
attacked the corporations for their bad service, and 
the corporations responded, with truth, that until 
the attitude of the public changed and these attacks 
ceased, bad service was all that could be furnished. 

A compromise was demanded in every interest. 

166 



THE CITY 

One of the best evidences of the essential sanity 
of the American people in their dealings with the 
problems of public business is the manner in which 
they have worked out, to a satisfactory solution, 
the problems of the relations between the city and 
the public-service corporation. How this has been 
done can best be told by a series of illustrations. 

The Chicago Railways Company owns and oper- 
ates about 450 miles of electric railway, serving 
the downtown sections as well as the entire north 
and west sides of the city of Chicago. This com- 
pany is the successor of two corporations which 
formerly operated these properties, and which, in 
their turn, represented consolidations of smaller 
companies. All these companies were greatly 
overcapitalized, and the service which they fur- 
nished was perhaps the worst in the United States. 

As a result of negotiations with the city of 
Chicago, which followed the refusal of the city to 
extend the franchises of the companies, an ordi- 
nance was passed dated February 11, 1907, and 
approved by the voters, which granted the Chicago 
Railways Company a twenty-year franchise. 
Under this franchise ordinance, the company was 
required to carry out a comprehensive plan of 
rebuilding the property. During the next two 

167 



THE CAREFUL INVESTOR 

years, the company spent about $29,000,000 on 
these improvements, and the property, on Feb- 
ruary I, 191 1, was appraised at $68,226,612. The 
city retains an option to purchase all of the prop- 
erties of the company for mimicipal ownership 
and operation at any time during the life of the 
franchise at a price equal to the valuation on 
February i, 1907, $30,779,875, plus all expendi- 
tures since February i, 1907, for reconstruction 
and extensions. 

In case the property shall not be purchased be- 
fore the expiration of the twenty years named in 
the franchise, the city agrees that it will not then 
grant a franchise to any other corporation for a 
competing system of street railways in this com- 
pany's territory, unless this corporation shall pur- 
chase the property of the company at the price 
specified. The city may require the company to 
sell this property to some other corporation or may 
purchase it itself prior to 1927, but in either case 
the price paid shall be 20 per cent, above the 
$30,779,875, the original appraised value, plus the 
cost of the cost of all additions. The franchise 
fiu-ther provides for a straight five-cent fare, with 
universal transfer. 

An important feature of the agreement is the 
168 



THE CITY 

division of the earnings. For the first time, a 
large American municipality asserted its right to 
participate in the profits of companies owning and 
occupying its streets for the purpose of profit. 
The agreement provides that out of the gross 
earnings of the company there shall first be paid 
all taxes and fixed charges for maintaining the prop- 
erty and replacing it, and 5 per cent, upon the 
value of the properties as increased from time to 
time. What remains is called surplus earnings. 
Of these earnings, the city is entitled to 55 per 
cent, and the company to 45 per cent. 

This contract has proven to be profitable for 
the city, and it is expected that in time it will be 
profitable for the company. For the year 191 1- 
12, the net income from the operation of these 
lines was $1,494,375. Of this amount the city of 
Chicago received, as its share in the municipal 
enterprise, $821,906, and the company received 
$672,469. The company has excellent credit, and 
its property has been completely reconstructed, 
all this work being done under the supervision of 
a Board of Supervising Engineers responsible to 
the city. The service is now excellent. 

In spite of the fact that the bonds of this com- 
pany are issued tmder what is known as an open- 

169 



THE CAREFUL INVESTOR 

end mortgage — that is, a mortgage which places 
no limit upon the amount of bonds to be issued — 
the careful supervision of the expenditure of the 
proceeds of the bonds, and the great security 
which the investor feels in the contract with the 
city of Chicago, has maintained prices for these 
bonds, which, when one considers the large amoimt 
issued, and the unsavory reputation of Chicago 
traction securities before the passage of this ordi- 
nance, must be regarded as remarkably high. 

The settlement of the transit problem in Phila- 
delphia proceeded along different lines, although 
the same imderlying principle of partnership be- 
tween the city and the company was followed. 
The street-railway system of Philadelphia had 
been controlled since July i, 1902, by the Phila- 
delphia Rapid Transit Company. This company 
succeeded in operation and control to the Union 
Traction Company, which was the successor of 
three former consolidations. The method of con- 
solidation in each case was a lease of the imderlying 
companies to a controlling company at a high rate. 

These successive increases in rentals from one 
consolidation to another were paid without diffi- 
culty so long as the street-railway system was 
operated by surface lines. The population grew 

170 



THE CITY 

steadily, and the earnings rapidly increased. 
When the Rapid Transit Company entered the 
field, however, it became necessary to invest a 
great s\im in an elevated and subway property, 
to build additional power plants, and to replace 
a large amount of track and equipment. The 
Rapid Transit Company spent, approximately, 
$50,000,000 on the system. In spite of this enor- 
mous outlay, however, the profits did not increase. 
Many complaints were also made of the inade- 
quacy of the service furnished by the company. 
It was proposed that the city should exercise the 
reserved right of purchasing the company's prop- 
erty, that franchises shotdd be granted to compet- 
ing companies if they would agree to good service, 
and that the company should be forced to place 
its overhead wires in underground conduits. These 
persistent attacks upon the company seriously 
injured its credit, and transportation develop- 
ment was at a standstill. 

Under the inspiration of an association of retail 
merchants, in 1907, the year that marked the con- 
clusion of the Chicago agreement, the relations 
between the Rapid Transit Company and the 
city of Philadelphia were adjusted by an agree- 
ment. This agreement provided for a community 

171 



THE CAREFUL INVESTOR 

of interest between the city and the company. The 
company agrees that it will not make any issues 
of stocks or bonds without first obtaining the 
approval of the city; that if the city shall at any 
time decide that new lines should be built, it shall 
notify the company to build such new lines, and 
if the company does not accept the plans of the 
city in this respect, the city may offer the right 
to construct such roads to any other corporation; 
that the mayor and two citizens shall represent 
the city on the board; and that the city is to 
share equally with the company in all dividends 
above the return of 6 per cent, to the share-holders, 
which, however, since no dividends have been paid, 
stands as an accumulated charge in favor of the 
stock-holders and against the city; that the com- 
pany relinquishes its right to build a subway 
bisecting the city from north to south, allowing 
the city to make any other arrangement which may 
seem desirable for its construction; and that the 
company shall maintain a sinking fund which, 
beginning July i, 191 2, shall amovmt to $120,000 
a year for ten years, and shall thereafter increase 
until $5,000,000 has been acctimulated, which shall 
then be paid into the city treasury, and all future 

sinking fimd payments made to the city treasurer. 

172 



THE CITY 

In addition to the sinking-fund payments, the 
company, during the first ten years, in lieu of all 
obligations for paving, removal of snow, license 
fees, etc., shall pay into the city treasury the sum 
of $500,000, this increasing until, during the last 
ten years of the agreement, it shall reach $700,000. 
On July I, 1957, or on any July i thereafter, the 
city reserves the right to purchase all the property, 
leaseholds, and franchises of the company for an 
amount equal to the par value of its capital stock 
outstanding, at the date of agreement $30,000,000, 
plus any additional stock issued with the consent 
of the city. The money paid into the sinking fimd 
is to be available to the city in part purchase of 
the property of the company, should the city elect 
to exercise its option. 

Upon the acceptance by the company of this 
agreement, the city confirmed all of the franchises 
and rights of the company and its subsidiaries,! 
many of which had been called into serious ques- 
tion, and provided that the rates of fare then 
obtaining could be changed only with the consent 
of both parties. 

This agreement finally laid to rest all the appre- 
hensions of investors in Philadelphia street-rail- 
way stocks and bonds as to the legal security of 

173 



THE CAREFUL INVESTOR 

their investment. It made the city and the com- 
pany partners in their transportation system. It 
gave the city what will eventually be a substantial 
interest in the properties of the company. It 
insured a large measure of control by the city 
officials over certain features of the management 
of the company. It made provision for the future 
growth of the system by the construction of addi- 
tional lines. It also reserved to the city the right 
to acquire a property which in 1957 will be enor- 
mously valuable, at a price w^hich is reasonably 
certain to represent but a portion of its value. 

New York City has gone still further in the 
harmonizing of the relations between the city 
and the public-serv^ice corporation. New York 
has worked out a plan for utilizing the credit of 
the city in the construction of subway lines for 
which private capital could not be secured on 
advantageous terms. In the case of the original 
subway, the city furnished all the money for con- 
struction. Large extensions of this system are 
now in progress, which will be paid for in part by 
the companies and in part with public money. 
The leases and contracts under which the city 
fiimishes this money are made on terms which 

provide for the payment of interest on the city 

174 



THE CITY 

bonds issued to provide these funds, plus a sinking 
fund. The right of purchase at the end of a term 
of years is reserved. They represent the furthest 
development in the cooperation between the city 
and the municipality. "^ 

The rights of the public either to own their 
transportation system or to retain the reserved 
interest, and, in the meantime, to share in the 
profits; to supervise, in so far as is necessary to 
secure good service, construction and operation; 
and to regulate the capitalization to prevent 
inflation, are now established. In return, the 
public has come to recognize its obligation to pro- 
tect the companies in the enjoyment of liberal 
franchise privileges for a fixed term of years, to 
secure adequate compensation for all their outlay 
of capital ; and, at the end of the franchise period, 
in case it is not deemed wise to extend these privi- 
leges, to pay to the company a fair compensation 
for the property. Finally, if New York is to be 
taken as the most advanced type of municipal 
cooperation with public-service corporations it is 
now recognized as a proper function of municipal 
government, to provide, by the use of the public 
credit, for the construction of subway lines, which 

are then to be turned over for operation to private 

175 



THE CAREFUL INVESTOR 

corporations. The public-service corporations, in 
their turn, have not only recognized the right of 
the people to ownership and control, but also to 
share in the profits of operation. 

Ten years ago there was much talk of miinicipal 
ownership and operation of public utilities as the 
only escape from a situation which, all agreed, 
was fast becoming intolerable. To-day, while 
municipal ownership, actual or reserved, is now 
accepted without question, the talk of mimicipal 
operation has entirely disappeared. The American 
city and the public-service corporation have en- 
tered into a partnership for mutual advantage.. 
As a result of this partnership, the position of 
public-service corporations before the public and 
with the investor has been much improved. 



XV 

THE PUBLIC-SERVICE COMMISSION AND 
THE INVESTORS 

We have examined the methods employed by the 
investment-banker in investigating the securities 
of public-service corporations. We saw with what 
great care these investigations are made, and with 
what searching scrutiny every factor bearing upon 
the merits of the enterprise is considered. As 
a result of these careful examinations, the number 
of failures among public-utility corporations is 
each year diminishing, and the investor can buy 
these securities with confidence. 

Supplementing the work of the investment- 
banker, although undertaken with a different 
motive, many States have established administra- 
tive bodies known as Public-Service Commissions, 
who are charged with the duty of supervising the 
rates and prices, the service, and, incidentally, the 
capitalization, accounting methods, and financial 
policy of public-service corporations. The primary 

* Note. — This chapter is substantially identical with Chapter 
VI in the author's Corporation Finance. 
12 177 



THE CAREFUL INVESTOR 

object in the establishment of these commissions 
has been to protect the public against bad service 
and excessive rates and prices. 

In order to make sure that corporations subject 
to their jurisdiction are honestly capitalized, so 
that they may not have any inducement imduly 
to advance rates in order to pay interest and divi- 
dends on capitalization representing no actual 
value, and in order that the proceeds of their sales 
of stock and bonds should be applied to the im- 
provement of their plant and to the consequent 
betterment of their service, some of the Public- 
service Commission laws clothe the commissions 
with authority over the issue of securities. 

The nattire of this power over security issues is 
indicated by the following extract from the Act 
Creating the Public-Service Commissions of New 
York: 

Any common carrier, railroad corporation or street railroad 
corporation organized under the laws of the State of New York, 
may issue bonds, stocks, notes or other evidences of indebtedness 
payable at periods of more than twelve months after the date 
thereof, when necessary for the acquisition of property, the con- 
struction, completion, extension or improvement of its facilities, 
or for the improvement or maintenance of its service or for the 
discharge or lawful refvmding of its obUgations, provided and 
not otherwise that there shall have been secured from the proper 
commission an order authorizing such issue, and the amount 
thereof and stating that, in the opinion of the commission, the 

178 



THE INVESTOR 

use of the capital to be secured by the issue of such stock, bonds, 
notes, or other evidences of indebtedness is reasonably required 
for the said purpose of the corporation. For the purpose of 
enabling it to determine whether it should issue such an order, 
the commission shall make such inquiry or investigation, hold 
such hearings and examine such witnesses, books, papers, docu- 
ments or contracts as it may deem of importance in enabling 
it to reach a determination- 

Under this power, every corporation proposing to 
issue or authorize any securities must apply to the 
Public-Service Commission for authorization, and 
the new securities will not be sanctioned imless 
the Commission is first satisfied that the issue is 
for the best interests of the company. The method 
of procedure in cases involving the authorization 
of bond-issues is outlined by the Commission of 
the Second District of New York in its second 
annual report, as follows : 

In passing upon the application for leave to issue additional 
capital stock, the Commission will consider: 

Whether there is reasonable prospect of fair return upon the 
investment proposed, to the end that securities having apparent 
worth but actually little or no value may not be issued with our 
sanction. 

We think that to a reasonable extent the interests of the 
investing public should be considered by us in passing upon these 
applications. 

The Commission should satisfy itself that, in a general way, 
the venture will be likely to prove commercially feasible, but it 
should not imdertake to reach and announce a definite conclusion 
that the new construction or improvement actually constituted 

179 



THE CAREFUL INVESTOR 

a safe or attractive basis for investment. Commercial enterprises 
depend for their success upon so many conditions which cannot 
be foreseen or reckoned with in advance, that the duty of the 
Commission is discharged as to applications of this character 
when it has satisfied itself that the contemplated purpose is a 
fair business proposition. 

Although the Commission here expressly dis- 
affirms its intention to guarantee the securities 
whose issues it sanctions, yet its method of pro- 
cedure is so careful as actually to reach this result. 
This method is as follows : 

An estimate will be made from a consideration of the results 
of operation of existing roads of the probable gross earnings. 

An estimate will be made in like manner of the probable oper- 
ating expenses, taxes, and depreciation charges. 

The excess of earnings over the disbursements whJch must be 
made before fixed charges can be met represents the sum which 
is applicable to fixed charges. 

The maximum bond issue which will be allowed must be 
determined by the sum thus ascertained to be applicable to the 
payment of the interest charge. 

No bond issue should be permitted creating an interest charge 
beyond an amount which it is reasonably certain can be met from 
the net earnings. 

Stock representing a cash investment should be required to an 
amount sufficient to afford a moral guarantee that, in the judg- 
ment of those investing, the enterprise islikely to prove commer- 
cially successful. 

The order authorizing such stock and bond issues will contain 
approximate provisions designed to secure the construction of 
the road in accordance with the plans and specifications upon 
which the authorization was made and not in excess of the actual 
requirements. 

180 



THE INVESTOR 

If the allowance proves inadequate for the required purposes, 
an application for further capitalization may be made, upon 
which application the expenditure of the proceeds of stock and 
bonds already authorized must be shown in detail. 

After an issue of bonds has passed successfully- 
through the ordeal of this investigation, the inves- 
tor need have little fear concerning their safety. 

There is another aspect of the Public-Service 
Commission matter which is even more reassuring 
to the investor. When a Public-Service Commis- 
sion has authorized the issue of securities, it is, by 
implication, bound to protect the company whose 
application it has authorized, not merely against 
the action of their directors in borrowing money 
or issuing stock against the best interests of the 
corporation, but also to protect them against 
competing enterprises for which there is no public 
necessity, and which would not, therefore, prove 
profitable. The best recent example of the pro- 
tection which the Public-Service Commission gives 
a company whose capitalization and rates are 
subject to its jurisdiction, is in the refusal of the 
application of the Buffalo, Rochester and Eastern 
Railroad for authority to issue securities for the 
construction of a line of railroad from Buffalo to 

Albany which was to parallel the Hne of the New 

181 



THE CAREFUL INVESTOR 

York Central. The ground of the refusal was that 
there was no necessity for the new line, that it 
would not prove profitable, that it would injure the 
New York Central, and that no public benefit would 
result. A summary of the conclusions of the Com- 
mission upon these various matters is as follows : 

First, that the cost of the proposed road would 
be about $100,000,000. 

Second, that existing railroad facilities between 
Buffalo and the Hudson River were adequate to 
take care of existing business and for a very large 
increase in future trafiic. 

Third, that the cost of the proposed road would 
require a capitalization of $336,700 per mile, much 
larger than the capitalization of any railroad sys- 
tem in the country. 

Fourth, that this capitalization would require 
earnings per mile of at least $48,100, if 5 per cent, 
was to be earned on the amount invested. 

Fifth, that to earn this sum would involve a 
traffic greatly in excess of the traffic of any rail- 
road in the coimtry. 

Sixth, that the proposed road would not be able 

to forward its freight over its eastern connections 

at the Hudson River, since these were already 

over-taxed. 

182 



THE INVESTOR 

Seventh, that the proposed road did not con- 
template any benefit to the public in the reduction 
of rates, and, finally, that the applicant had not 
shown sufficient financial ability to justify issuing 
to it a certificate of public convenience and neces- 
sity to construct a road costing $100,000,000. 

If the Public Service Commission of New York 
had been in existence thirty years ago, the imneces- 
sary, costly, and wasteful West Shore and Nickel 
Plate Railroads, which were constructed for no 
other purpose than to divide traffic which the 
New York Central and the Lake Shore and Michi- 
gan Southern were handling with economy and 
despatch, would not have been authorized, and a 
large amoimt of the reckless railroad construction 
west of the Mississippi, which bankrupted the 
Atchison, Topeka and Santa Fe, the St. Louis 
and San Francisco, and assisted in breaking down 
the Northern Pacific, would not have been sanc- 
tioned. 

The Public-Service Commission not only pro- 
tects the investor against the inevitable conse- 
quences of competition where no necessity for the 
competing property exists, but it also secures his 
company in the right to charge such rates and 

fares as will yield a reasonable return on securities. 

183 



THE CAREFUL INVESTOR 

At the time the New York Public-Service Com- 
missions were instituted, the most serious apprehen- 
sions were expressed by financial interests that the 
new laws which took from directors and stockhold- 
ers most of the control which they had previously 
exercised over the issues of new securities would 
seriously interfere with the efforts of companies to 
provide new capital. As the Commissions have 
progressed, however, since they have been forced 
into the position of virtually guaranteeing every 
issue which they approve on the basis of a careful 
investigation of the prospects of the enterprise, a 
critical examination of its engineering features, the 
rock on which so many new schemes are wrecked, 
and an assurance to the investor that reasonable 
rates will be allowed and that cut-throat competi- 
tion will be prevented, they have come to be very 
favorably regarded by investment bankers. 

The bond-salesman who can offer a security 
whose issue has been approved by some public- 
service commission has his work of persuasion 
largely accomplished. Indeed, the sentiment 
among investment-bankers is nearly unanimous 
as to the benefits which have come to their business 
from the work of these regulative bodies. 



184 



XVI 
FARM MORTGAGES 

A FARM mortgage does not differ from any other 
mortgage. It is a promise to pay one, two, five, 
or ten thousand dollars in three or five years from 
date, and it is secured by the mortgage which 
conveys, in trust, to the lender the title to the 
mortgaged property. This conveyance is recorded 
in the county in which the property is located, 
thus establishing the claim of the lender as a first 
lien upon the mortgaged premises. The advan- 
tages and disadvantages of this form of mortgage, 
as compared with an investment in the bonds of 
a large corporation, may be stunmarized as follows : 

The first advantage of the farm mortgage is its 

high yield. The Central West, the part of the 

country in which mortgage loans are preferably 

made by conservative investors, is now making 

loans on a 6 per cent, basis to the investor. The 

Western States, as a nile, do not tax at home 

investments in foreign loans, and this gives the 

investor the opportimity to realize the full interest 

return. 

185 



THE CAREFUL INVESTOR 

The second advantage of the farm loan is its 
early mattirity. The purchaser of a bond of a 
railway company cannot get his money back from 
the company for, perhaps, thirty or even fifty 
years. His only way of recovering his principal 
is to sell his bond to some other investor. This 
involves the risk of depreciation in the principal. 
The investor may have purchased his bond for 
105, and when he comes to sell, it may have de- 
clined to 99K> owing to a falling-off in the demand 
for securities of that character. The bond is still 
perfectly good, his interest will be paid regulariy, 
but he has sustained a loss on the capital value of 
his investment. The investor in a farm mortgage, 
however, can get his money back from the bor- 
rower at the end of three or five years. 

The third point in favor of the farm mortgage 

is closely connected with that just mentioned, 

namely, the greater control which the investor has 

over his investment. Provision is usually made in 

the mortgage for an indefinite extension from year 

to year at the expiration of the term named in the 

instrument. When this provision is included, if 

the investor wishes the return of his principal at 

the end of the term, he can have it. If he wishes 

a longer-term investment, he can allow the mort- 
ise 



FARM MORTGAGES 

gage to run from year to year. A good farmer 
can make more than 6 per cent, by investing 
money in buildings and improvements and in land, 
and often is not anxious to pay off his mortgage. 
At the end of any year, however, the mortgage 
can be called up and the investor can get his 
money. 

All mortgages, moreover, whether issued by a 
great railway company or by a small farmer in North 
Dakota, provide that the borrower should keep 
his farm, which is the lender's security, in good 
condition and the buildings in good repair. It is 
almost impossible for the investor in a corporation 
bond to enforce these provisions. He is only one 
of perhaps 2,000 bond-holders; he is represented 
by a trustee, and he must rely upon the trustee 
to enforce the terms of the mortgage. It is not 
the custom for the trustee, whatever powers may 
be given him by the mortgage instrument, to 
interfere with the management of the company. 
Instances have occurred where the security of 
mortgage bonds has been seriously impaired be- 
cause of long-continued neglect of the property. 
This is not possible with the farm mortgage, or 
with any other form of real-estate obligation, 
where the security of each loan is a single piece of 

187 



THE CAREFUL INVESTOR 

property, and where the investor has the oppor- 
tunity of inspection. 

Against these advantages of farm-mortgage 
loans, certain disadvantages are urged. Some of 
these disadvantages are inherent in this form of 
obHgation; others can be overcome by employing 
the services of reputable mortgage-brokers. The 
first point urged against the farm mortgage is its 
short duration. At the end of a few years, the 
lender may have his money handed back to him, 
and be obliged to look for a new investment. In 
practice, however, this objection is not serious. 
Either the mortgage is allowed to run from year 
to year, or a new investment of equal security can 
be obtained without difficulty. 

Then, too, it is urged against the farm mortgage, 
that the appHcation of the proceeds of the mort- 
gage to productive purposes is not safeguarded as 
it is in a bond executed by a corporation. When a 
railroad company, for example, puts out an issue 
of bonds whose proceeds are to cover the construc- 
tion of a branch line, the bonds will not be issued 
by the trustee to the banking house except upon 
the certificate of the company's engineer that a 
certain amount of mileage has been constructed. 

Not until the whole improvement has been com- 

188 



FARM MORTGAGES 

pleted, will the entire number of bonds be issued. 
In corporation mortgages, the attempt is always 
made to provide for the productive expenditure of 
the proceeds of the bonds. "Spendthrift bor- 
rowing" is not possible. 

With farm mortgages this safeguard is not 
usually provided. The security is stated, but the 
purposes to w^hich the money is to be applied are 
not given. In a number of applications for farm 
loans which I have before me, no questions are 
asked concerning the use which the borrower will 
make of these funds, nor is any attempt made to 
condition the payment of the money upon the 
certificate of some third party that a certain invest- 
ment of the money is assured. This information 
can usually be obtained by the investor, however, 
either through the broker or, if he lends the money 
in person, from the borrower. There is no reason 
why farm-mortgage loans should not be strength- 
ened by providing this very important safeguard. 

The objection is often made to farm mortgages 

that they are not available for either quick sale 

or as collateral. This objection is, in the main, 

well foimded. Farm mortgages share this defect, 

however, with many imlisted bonds. Bonds 

secured by first mortgage on a property of a small 

189 



THE CAREFUL INVESTOR 

gas company, for example, have a very slow and 
uncertain market, and are only available for col- 
lateral at institutions where the property and the 
borrower are well known. If the investor in Massa- 
chusetts buys a farm mortgage secured on lands 
in North Dakota, his only method of selling the 
mortgage is to place it through a broker, who will 
charge him a commission for selling it. He can 
also use it as collateral about as well as he could 
use an unlisted bond at a bank or trust company 
where his character and standing are well known, 
but whose officers are not familiar with the value 
of the property securing the bonds. 

The availability of farm mortgages as collateral 
is also restricted by the prohibition in the national 
banking law against lending on real-estate mort- 
gages. This prohibition does not apply, however, 
to loans by many other financial institutions. 

It must be admitted that the farm mortgage 
has a slower market than the corporation bond, 
although it can be sold through the same channels 
as those through which it was purchased. It is 
also not easy to borrow upon farm mortgages. 
These objections, however, apply only to the 
mortgage as a business man's investment. To the 
investor who is looking for a safe place for his 

190 



FARM MORTGAGES 

money, who does not expect to sell, and who does 
not need to borrow, this argument against the 
farm mortgage does not apply. There is, finally, 
the objection to the Western farm mortgage from 
the standpoint of the Eastern investor, that the 
lender is sending his money often 2,000 miles 
away, lending it to a man whom he has never seen, 
on the security of property which he will never 
view, and taking a variety of risks and hazards, 
for example, of drought, sickness, etc., from which 
an investment in corporation or municipal bonds 
is entirely free. 

It is this situation which calls the mortgage- 
broker into existence. Without his intervention, 
it would be impossible for the eastern investor to 
put his money into Western farm mortgages. The 
experienced and reliable mortgage-broker, how- 
ever, who is merely an investment-banker in a 
specialized field, is able to remove these objections 
to mortgage loans. 

An outline of the service which the broker per- 
forms for the investor will show how indispensable 
this service is. I take this description from a book- 
let issued by a mortgage company doing business 
in a Northwestern State, and which has been in 
business for 34 years, with whose standing I am 

191 



THE CAREFUL INVESTOR 

personally acquainted, and for the accuracy of 
whose statements I can vouch. The amount of 
loans offered for investment by this company are 
usually from 30 to 40 per cent, of the actual market 
value of the loan. The term of the loan is five 
years. When desired by the borrower, the privi- 
lege is extended of repayment of part of the loan 
with interest date. Such repayment increases the 
margin of security in the property, and the money 
can be reinvested in other mortgages if desired. 
The average size of the loan is about $2,000. 
These loans are made by the company with its 
own money after personal examinations of the 
property. 

The method of making farm loans is as follows : 
The farmer wishes to borrow money for additional 
buildings, for the purchase of live stock, or for 
payment for land. He makes application to the 
company for a loan secured on his land. His appli- 
cation furnishes complete information about his 
land, his equipment, buildings, live stock, and 
machinery, as well as personal information about 
himself, his farm, his neighbors, and general 
neighborhood conditions in his locality. 

Of special interest in this connection is the 
detailed information which is obtained concerning 

192 



FARM MORTGAGES 

the borrower. Some of these questions are ex- 
tremely personal. The following is a specimen list : 

1. Full name and age of borrower. 

2. Married or single. 

3. Full name and age of wife. 

4. If formeriy married, state wife's full name and whether 

divorced or deceased. 

5. If deceased, state whether she left a will, and if so when 

and where the same is probated. 

6. If divorced, state where the decree is filed. 

7. State name, sex, ages, and residences of children by di- 

vorced wife. 

8. Have you any who are dependent upon you aside from 

your own family? 

9. What is the general physical condition of your family? 

10. Give name, sex, and age of your children. 

11. What ones live at home with you? 

12. Husband bom where? 

13. Wife born where? 

14. Belong to church? 

15. Belong to fraternal societies? 

16. Politics? 

17. Do you drink, and if so to what extent? 

The purpose of obtaining this detailed informa- 
tion is both for the sake of security and that the 
prospective investor may have an accurate knowl- 
edge of the character of the man to whom he is 
lending his money. It also assists the attorneys 
for the mortgage company in searching the title. 

From this information, the loan committee of 
the company passes judgment on the loan applied 

13 193 



THE CAREFUL INVESTOR 

for. If it is approved, the information is, as far 
as possible, verified on the ground by their own 
examiner. The title to the property is then ex- 
amined by their attorneys. If foimd perfect, 
papers for signature and amotmt agreed upon as 
a safe loan are sent to their agent for the final 
settlement, and the mortgage is recorded at the 
coimty seat. The complete papers are then as- 
sembled and, after proper record is made, are given 
a mortgage number and become a part of the 
investment. The papers in a mortgage envelope 
consist of note and mortgage, assignment of 
mortgage, abstract of title, insiirance policy, if 
any, application and examiner's report. The 
mortgage company guarantees each title. 

The mortgage company not only makes a careful 
investigation of the quality of the mortgage, but 
during the period of investigation it assimies the 
entire management of the loan. A record is kept 
which enables the company to ascertain whether 
the farmer's taxes and insurance premiimis are 
promptly paid, and to collect his interest, as well 
as the principal sum, when due. This provision is 
made without expense to the owner of the mort- 
gage, and the company's profit, moreover, is paid 

by the borrower. 

194 



FARM MORTGAGES 

Two illustrations of the mortgages offered by 
this concern will show the quality of the security 
which is furnished. The names are fictitious: 

JAMES W. BROWN 

|2,ooo County, North Dakota. 

This mortgage is dated December 1,1910, and is due December 
1, 1915. The loan is secured upon N. E. yi 30-133-62, 140 acres 
under cultivation and 20 acres fenced to pasture. It is otherwise 
improved by a set of buildings costing $1,200 or $1,300, carrying 
insurance for $800. The borrower has stock and machinery suffi- 
cient to run his farm, and is worth about $3,000 all clear of en- 
cumbrances. The soil is a rich, heavy black loam, with clay 
sub-soil. This quarter, I think, would readily sell at $45 or $50 

an acre. The land is situated about ^}4 miles from , 

and the loan is being made to pay a loan now on the land. 



C. F. EVERHARDT 

$4,500 County. 

This mortgage is secured upon 280 acres of land about five 

miles north and west from . The borrower is a 

German, and has resided here more than twenty years. 160 
acres of the land are now under cultivation and the balance 
fenced to pasture. It is otherwise improved by buildings costing 
$2,500. I do not believe that the land could be bought for less 
than $50 an acre. It is a loan that I can recommend in the 
highest terms. 

Loans made on this character of security are not 

open to question. When the broker is reliable — 

and the investor can usually ascertain this fact 

through his local bank — so that his statements can 

195 



THE CAREFUL INVESTOR 

be relied upon, an investment in a farm mortgage 
is as safe as an investment in any other form of 
security. The farm-mortgage investor has the 
advantage of a high-interest rate, and, if this is 
an object to him, an early maturity of his loan. 
Against this higher rate must be balanced the 
slower market and the greater difficulty in bor- 
rowing on the mortgage, as compared with a mort- 
gage bond of first quality. 



XVII 
THE MORTGAGE BANK 

Productive land furnishes the ultimate security 
for the investor. Outside of the mining industry, 
which contributes but little to the supply of invest- 
ment securities, all other forms of investment rest 
directly or indirectly upon the farms. Railway 
traffic mainly comes from the farms. The farms 
furnish most of the raw material of manufacture. 
As yet, however, there has been little realization 
of the farms themselves as a basis of investment. 
The railroads of the United States are worth, in 
round numbers, $20,000,000,000. This entire 
value is outstanding in the hands of the investors 
in the form of stocks and bonds. The amount of 
securities issued by industrial corporations is 
probably greater than the value of the property 
which these companies own. Public-service cor- 
porations are fully represented by investment 
securities. It is only in the field of real estate, 
however, and particularly farm real estate, that 
investments still lag far behind value. 

According to the census, there are in the United 

197 



THE CAREFUL INVESTOR 

States 6,361,502 farms, containing a total of 
878,798,000 acres. The total value of this farm 
property is estimated at $40,991,000,000, of which 
over two-thirds represents the value of the land, 
one-sixth the value of the buildings, and one-sixth 
the combined value of the improvements, machin- 
ery, and live stock. The total value of this farm 
property has more than doubled during the decade 
1900 to 1 9 10. The increase in farm land alone has 
been 1 1 8. i per cent. The average value per acre of 
the American farm increased from $15.57 in 1900, 
to $3 2 .40 in 1 9 1 o. The explanation of this phenom- 
enal increase in land values is found in the fact that 
while the total population increased 21 per cent, 
since 1900, the urban popidation increased 34.8 per 
cent, and the rural popiilation only 11.2 per cent. 
The nimiber and acreage of farms increased much 
less rapidly than the total population. The value 
of farm products, as a consequence of this steadily 
growing demand from cities and towns for food 
supply, has been rapidly advancing, and has made 
agriculture easily a most profitable business. 

This great industry, however, is but little known 
to the investor. The savings banks and insurance 
companies, and, to a less extent, the commercial 
banks and trust companies, have realized the 

198 



THE MORTGAGE BANK 

value of the perfect security which the farm mort- 
gage offers, but to the individual investor in the 
East these advantages are almost unknown. 

It is unfortunate for the United States that this 
is the case. The great problem before the Ameri- 
can people to-day is the rising cost of living. How- 
ever economists may wrangle about the ultimate 
imderlying cause of the advance of the price of 
bread and meat, the plain explanation of this fact 
is that there is too little bread and too little meat. 
The only cure for the high prices of food is to 
produce more food. The production of food is 
largely a matter of the investment of capital. The 
time of free land with soil six feet deep, which 
would produce 20 crops of grain in succession 
without fertilizer, is past. An extension of the 
farms in the United States to-day means costly 
improvement in drainage and irrigation, large 
expenditures on improved farm buildings, farm 
machinery, fertilizer, and improved live stock. 

The total area of lands in the United States 

which are to be reclaimed in whole or in part by 

drainage is estimated at 225,000,000 acres. Of 

this amount, 75,000,000 acres are in swamps 

entirely unproductive, while 150,000,000 acres 

include land whose productivity could be increased 

199 



THE CAREFUL INVESTOR 

at least 20 per cent, by drainage. This is equal to 
the combined area of Germany, Great Britain, 
Belgium, and Holland. It is estimated that this 
area would sustain a population of 125,000,000, 
and would add $4,000,000,000 a year to the public 
wealth of the United States. In Florida alone 
18,000,000 acres of land can be reclaimed by 
drainage. 

These impressive figures give some idea of the 
problem before the American farmer and the 
American consumer. The farmer must have more 
capital. Mr. James J. Hill, a few years ago, 
aroused much discussion by the statement that 
the railroads of the United States required a capi- 
tal investment of $1,000,000,000 a year for at 
least five years in order to fit them to handle 
economically the traffic which would be offered. 
The needs of the railroads are insignificant com- 
pared with the needs of the farms. The crying 
need of the United States to-day is for larger 
investment in agricultiu*e. 

The need of a large investment in farm mort- 
gages is great. Without this investment, the 
problem of the futiu-e food supply is certain to 
grow more and more perplexing. And yet, with 

the present machinery of farm investment, it is 

200 



THE MORTGAGE BANK 

unreasonable to expect any large increase in the 
movement of money into this field. The method 
of investment in the farm mortgage has already 
been explained. The investor in Pennsylvania or 
in New York must lend $3,000, $5,000, or $10,000 
to a man in Oklahoma or Nebraska or North 
Dakota whom he has never seen, and whom he 
knows only through the statements made to him by 
the broker. This loan is for a limited time. At the 
end of that time, he fears that his money may be 
handed back to him, and he will have to make a 
new investment, shifting and changing from one 
thing to another. If he deals with reliable brokers 
whose names he can readily obtain through his 
local bank, he runs, it is true, no risk of loss, but 
the form of the investment does not commend 
itself to him. 

The Eastern investor is accustomed to purchas- 
ing stocks and bonds of the large railroad and 
industrial and public-service corporations, issued 
in $50,000,000, $100,000,000, and $200,000,000 
lots. He buys standard securities — issued by 
wealthy corporations with whose operations and 
history he has long been familiar, and which he 
regards as permanent institutions. It is natural 

that he should prefer 4>^ and 5 per cent, income 

201 



THE CAREFUL INVESTOR 

from a railway bond or railway stock issued by 
such companies, to 6 per cent, on a farm mortgage. 

This prejudice in favor of standard securities 
will not soon be overcome. The farm-mortgage 
business has been vigorously pushed for many 
years, and yet other fields of investment which 
have been recently opened, such, for example, as 
the industrials, have absorbed several billions of 
dollars which it would have been to the national 
interest to put into farm mortgages. The farm- 
mortgage broker, with his present organization, 
cannot win the favor of the investor. If the farm 
mortgage is to reach the position which it deserves, 
the organization of the business must be changed, 
the institution of the mortgage bank must be 
established in this country. 

The mortgage bank is well known in every 

country of Western Europe. In Germany, as a 

recent investigation showed, there were 36 mortgage 

banks with capital of $170,563,000 and combined 

reserves of $66,711,400. These banks had $2,618,- 

000 loaned out on mortgage. Against these 

mortgages and to obtain the money for this 

investment, the banks had issued $2,548,000,000 

in bonds. Of this amoimt $1,571,000,000 were 

4 per cent, bonds and $977,000,000 were 33^ and 

202 



THE MORTGAGE BANK 

3>^ per cent. The German mortgage banks, by 
standardizing the farm mortgage, have been able 
to sell their bonds on better terms than the 
American railroads can obtain for their first- 
mortgage securities. 

The mortgage bank gathers together thousands 
of individual loans, consolidates them into one 
aggregate security, and upon this security issues 
a standard bond. In addition to the security of 
the mortgages, there is the capital and accumu- 
lated earnings of the banks. The same institu- 
tion, although less highly developed, is found in 
France, Russia, Austria, Italy, and, more recently, 
in Great Britain. 

From the standpoint of the borrower, the mort- 
gage bank offers great advantages. The American 
method of borrowing on farm security is to make a 
short-term loan from three to five years. At 
maturity, this loan is often reduced or paid off, 
and money which should properly go into the 
development of the farm is used to reduce the 
loan. If the loan cannot be paid off, a new loan 
must be placed, and this means a commission 
and material increase in the expense. A farmer 
who renews his mortgage from time to time is 

fortunate to escape with a total cost oi ^yi per 

203 



THE CAREFUL INVESTOR 

cent, on the money which he obtains, and, on 
this account, the fann mortgage is always looked 
upon as a burden which often becomes a curse. 

We find nothing of this kind in the railway 
field. Railway bonds are never paid off. When 
they come due, they are refunded into new bonds. 
The investor does not wish his money back; he 
merely wishes security for his income. As long 
as security can be furnished him, he knows that 
he can obtain the amount of his principal from 
some other investor to whom he can pass on the 
evidence of indebtedness in which he has placed 
his savings. He would have the same attitude 
toward the farm mortgage if this were offered to 
him as a standard seciuity instead of a small loan 
made on minute security to a stranger. 

Farm-mortgage banking in the United States 
has been attempted in the past with disastrous 
results. Diuing the eighties, the rapid develop- 
ment of the western portion of the Com Belt 
encouraged many brokers to market the bonds 
of such companies, secured by Western farm 
mortgages. A succession of crop failures through- 
out this region ruined many of these companies. 
The failure of the Lombard Investment Company, 

for example, inflicted heavy losses upon the East- 

204 



THE MORTGAGE BANK 

em investors. Mortgage banking, from these 
unfortunate experiences, fell into serious discredit, 
and it is only recently that interest in the subject 
has revived. It is to be hoped, in the interest 
of the nation's prosperity, and in order to place 
sound securities within the investor's reach, that 
this institution which has been perfected in Europe 
shall be speedily introduced into the United States. 



XVIII 

INDUSTRIAL BONDS AND RAILROAD 
BONDS COMPARED 

By industrial bonds we understand the bonds 
of manufacturing companies, corporations pro- 
ducing iron, steel, machinery of various kinds, 
textiles, refined sugar, etc. We exclude from the 
classification of industrial bonds the bonds of 
mining companies, and the bonds of so-called 
public service corporations which supply gas, 
water, light, and transportation to mimicipaHties. 

The investor must exercise great caution in 
purchasing industrial bonds. These bonds are 
attractive in that they usually pay 5>^ and 6 
per cent, interest, and can frequently be purchased 
at prices stifiiciently below par to add considerably 
to this yield. Their security, however, is, as a 
class, by no means so good as the security of the 
other classes of bonds which we have investigated. 

The bond-buyer, it shotdd be remembered, sur- 
renders a chance of participating in the increasing 
earnings of the company in exchange for a guar- 
antee of a fixed rate of return on his investment. 

206 



INDUSTRIAL BONDS COMPARED 

If this guarantee is in any way doubtful, the low 
price and the high interest return at which the 
bonds can be purchased will usually be found to 
be insufficient insurance against the risks of loss. 
Manufacturing companies, as a rule, cannot give 
these satisfactory guarantees of security. 

The causes of this inferiority of security can 
be best understood by comparing manufacturing 
industry, from the standpoint of permanence of 
the income out of which the interest on the bonds 
must be paid, with that industry upon which 
most of the securities of the United States are 
based — ^the business of railway transportation. 
The bonds of manufacturing companies are in- 
ferior to railway bonds for the following reasons: 

First : The demand for any manufactured prod- 
uct is less stable than the demand for railway 
transportation in the same territory. 

Second: Manufacturing companies are more 
exposed to competition than railway companies. 

Third: The location of manufacturing industry 
is more liable to frequent changes. 

Fourth: The personal equation enters more 
largely into the management of manufacturing 
companies than into railway management. 

Fifth: Manufacturing industry is more com- 
207 



THE CAREFUL INVESTOR 

plex, less visible, and, therefore, less easily under- 
stood by the investor than the business of railway 
transportation. 

Let us take these points up in order. The de- 
mand for the products of a single industry, such 
as steel, is limited to a small portion of the total 
mmiber of commodities produced. There are a 
thousand articles clamoring for the money of the 
consumer. At best each commodity can absorb 
only a portion of the demand. The demand for 
railway transportation, on the other hand, is 
represented by every commodity of commerce. 
It corresponds very closely to the entire supply 
of commodities produced. What is wanted in 
the earnings of a company to make its bonds 
secure is stabihty. Wide fluctuations in earnings, 
which bring them down close to the limit of fixed 
charges, always impair the security of the bonds. 
It is an acknowledged principle of trade that 
the broader the demand for the products of 
services of an industry, the more stable are its 
earnings. This principle is based upon the obser- 
vation that a large and diversified demand is but 
slightly affected by any single influence, while 
if this influence is left to operate by itself upon 
the price of a commodity or service, it produces 

208 



INDUSTRIAL BONDS COMPARED 

wide fluctuations. The withdrawal of 10,000 gal- 
lons from a stand-pipe appreciably affects the 
level of water in the pipe. If the same amount is 
withdrawn from the reservoir, however, there is 
no visible change. This illustration may be used 
to explain the instability of the demand for rail- 
way transportation as compared with the demand 
for coal, sugar, or steel. The railroad company 
is patronized by the producers of every commodity. 
What it loses in freight earnings from a decline in 
price or supply of one group of products, it often 
more than regains by advances in others. 

The manufacturing company, on the other hand, 
producing, at the most, only a small number of 
products, has no such compensation for a falling- 
off in demand. It cannot turn its plant to pro- 
ducing something else. The steel plant, for ex- 
ample, cannot turn to sugar, or the cotton mill to 
the production of shoes. A railroad, however, 
can turn from the transportation of hard coal 
to the transportation of soft coal, or from the 
transportation of grain to the transportation 
of manufactured goods, or from carrying iron ore 
to carrying sand, stone, and cement. It has a 
thousand uses for its plant, while the manu- 
facturing company has only one. The classi- 
14 209 



THE CAREFUL INVESTOR 

fied freight traffic of the Pennsylvania Railroad, 
for example, contains 36 general classes of freight, 
some of which comprise thousands of individual 
articles, and all of which, taken together, make 
up the 143,928,382 tons hauled by the Pennsyl- 
vania Railroad in 191 2. Each one of the manu- 
factured commodities which the Pennsylvania 
Railroad carries is produced by some industrial 
concern. Each one of these commodities is acted 
upon by a variety of influences which affect its 
supply and demand, and through these increase 
or diminish the profits of the business which 
produces it. 

The production of anthracite coal, for example, 
is reduced by a strike. As a result, the demand for 
bitimiinous coal is increased. A failure of the 
corn-crop reduces the profits of the farmer and 
stock-raiser. A reduction of the tariff lessens the 
profits of the sugar-refiner, and a reduction of the 
internal revenue duty on manufactured tobacco 
increases the profits of the tobacco trust. Profits 
and prices are in a state of constant change. No 
manufacturing industry can be certain of its 
earnings a year hence. 

But from these perturbations of commerce, the 
railway company is, to a large extent, protected. 

210 



INDUSTRIAL BONDS COMPARED 

The immense variety of its traffic prevents rapid 
changes in the gross amount. What is lost on 
one commodity is often regained on another, 
and the total tonnage is not reduced. The experi- 
ence of the Pennsylvania Railroad, during the 
anthracite strike of 1902, is in point. This road 
hauls both anthracite and bittmiinous coal. As 
a result of the strike, the anthracite traffic was 
cut off, and the anthracite railroads, such as the 
Reading and the Lehigh Valley, suffered a heavy 
loss. But the Pennsylvania hauled a large part 
of the bittmiinous coal which took the place of 
anthracite in the Eastern markets, and the in- 
creased earnings from this source more than offset 
the loss on anthracite coal. 

Manufacturing industry shows no such tend- 
encies toward stability. On the contrary, manu- 
facturing industry is growing constantly more 
specialized. In place of producing all kinds of 
shoes, for example, the shoe-manufacturer comes 
to specialize in women's and children's shoes, and 
then in women's shoes alone. A manufacturer 
of machine tools, as the demand for his product 
increases, will gradually concentrate his produc- 
tion upon lathes, and eventually he may concen- 
trate on a single type of lathe for speciaHzed work. 

211 



THE CAREFUL INVESTOR 

Large advances in specialization increase the 
liability to wide fluctuations in demand, corre- 
sponding changes in profits, and resulting insta- 
bility of security. 

Manufacturing industry is more exposed to 
competition than the railroad. A railroad com- 
pany has a natural monopoly. After the terri- 
tory through which its line passes has been fully 
settled, and the day of state and local donations 
of land and cash has passed away, competition 
becomes very difficult. More especially is this 
true because of the increasing expense of terminals 
in large cities. The Baltimore and Ohio was 
forced into bankruptcy in 1896, among other 
causes, by the cost of its entrance into Philadel- 
phia, where it hoped to compete with the Penn- 
sylvania; and the Gould interests, after spending 
$30,000,000 in an attempt to gain a foothold in 
Pittsburgh, have been practically forced from the 
field of competition in that city. Even where 
railway competition exists between the larger 
cities, the local traffic is generally free from its 
influence. Moreover, the way and structure of a 
railroad may be considered as a permanent plant 
to which the company is constantly adding. Rail- 
way equipment changes very slowly, and no faster 

212 



INDUSTRIAL BONDS COMPARED 

than it is worn-out. A well managed manufac- 
turing concern, on the other hand, is constantly 
throwing into the scrap pile valuable machinery 
which has been supplanted by some new inven- 
tion, which must be installed in order to meet 
competition. 

As a railroad grows, the value of its property is 
constantly being added to, and the cost of dupli- 
cating it increases to a point which renders it 
almost immime from the danger of competition. 

Manufacturing industry is seldom free from 
competition. Even the United States Steel Cor- 
poration, with all its advantages, has been unable 
to retain the control of the market of the steel 
trade in the United States with which it started. 
Its percentage of the total production has gone 
steadily down. Now that the Sherman law is 
being so effectively enforced, the possibility of 
monopoly in manufacturing industry may be con- 
sidered even more remote, since the combinations 
by which the monopolies of the past have been 
built up are put under the ban. 

Even the patent monopoly is subject to such 

conditions and limitations as to render it of little 

value in furnishing security for bond-issues. A 

patent expires at the end of seventeen years. 

213 



THE CAREFUL INVESTOR 

The originality of the invention must be tested 
in court before the patentee can be certain of 
legal protection in his right. If the invention 
proves valuable, there are always men or corpo- 
rations who will attack its originality in the hope 
of either invalidating the invention in whole or 
in part, or of receiving money to withdraw their 
claim. A recent illustration is the invention of 
the Taylor- White process for the manufactiire of 
tool steel, from which the owners for a ntimber 
of years drew a large income, but which was finally 
declared to be non-patentable. It is next to 
impossible, in this day of accumulated knowledge, 
to hit upon something which is absolutely new. 
Somewhere in the world, it may be in an obscure 
laboratory, or in a comer of some workshop, the 
most promising invention has been at least sug- 
gested, and a suggestion of anticipation is enough 
for a contest. 

The value of a patent, moreover, is constantly 
threatened by the danger of substitution. The 
end desired may be reached by some other road 
than the one upon which the patentee has the 
exclusive right to travel. As soon as the value 
of a patent is proved, men set to work upon the 

problem which it has solved in the endeavor to 

214 



INDUSTRIAL BONDS COMPARED 

find some other solution, and it is but seldom 
that one of them does not succeed. The writer 
knows of a case where a patent was granted for 
an improvement in a certain device, in which 
the only change was the substitution of a weak 
for a strong spring. As a basis for the security 
of investment, a patent is worthless. No well 
informed investor should, save in the most ex- 
ceptional cases, buy a bond of a company whose 
earnings are dependent on the monopoly of a 
patent. 

Even those manufacturing industries which 
rely upon the monopoly of their control of raw 
material are not secure. It was supposed, for a 
number of years, that the United States Steel 
Corporation had achieved a practical monopoly 
of the ore supply of the United States. Certainly 
its control was sufficient to put up the price of 
iron ore to a point which made it exceedingly 
difficult for the independents, who were obliged 
to purchase their ore, to make any money. These 
high prices of ore, however, stimulated the efforts 
to uncover any new supplies, and brought into 
use a large number of low-grade ores foimd in the 
Eastern States, which it was not profitable to 

work at former ore prices. Discoveries and 

215 



THE CAREFUL INVESTOR 

development in the northern coast of the island 
of Cuba also made enormous additions to the 
supply of available iron ore. At one mine on 
Nipe Bay, there is in sight over 500,000,000 tons 
of ore, which can be laid down along the Atlantic 
Sea-board at much lower prices than this same 
grade of steel can be furnished from the Lake 
Superior mines. 

The difficulty of achieving a monopoly of manu- 
facture is but another expression for the Hability 
of manufacturing industry to competition, and 
competition is always dangerous. It is true that 
a combination of good sense and good fortune 
may achieve success, but the danger of failure is 
always present; and even if success is achieved, 
its measure may be small. The constant immi- 
nence of competition makes the investor cautious 
about buying the long-time bonds of a manu- 
facturing company. He may buy the stock, off- 
setting the risk by the higher returns on the 
investment; but in a bond which pays, at best, 
only a moderate return, the maximtmi security 
is demanded. 

The three remaining considerations with which 
this discussion opened, bearing upon the infe- 
riority of manufacturing bonds as compared with 

216 



INDUSTRIAL BONDS COMPARED 

railroad bonds, may be passed briefly in review. 
The location of manufacturing industry is subject 
to sudden changes. A large part of the heavy iron 
and steel trade which was formeriy controlled by 
Pittsburgh, is now passing to the Chicago district, 
and the Northwest, it is expected, will be served 
from the plants erected at Duluth. The great 
textile and boot and shoe industries of New Eng- 
land are in danger of arrested development, due to 
the steady progress of the sentiment in favor of 
a strict application of the long and short haul 
clauses. New England has been able to live and 
thrive because of the exceedingly low railroad 
rates which they receive on their raw materials 
shipped in and on their manufactured products 
shipped out. If the long and short haul clause 
is strictly applied, and the railroad prevented 
from charging the same rate for a long haul as 
it charges for short distances, the industries of 
New England must seek new outlets in the foreign 
trade for the domestic business which will be lost 
to them by the developments in the West and 
the South. 

The personal equation is far more important 
in manufacturing industry than in railroading. 
Take, for example, the immense strides which 

217 



THE CAREFUL INVESTOR 

the Bethlehem Steel Company has been making 
under the leadership of Charles M. Schwab, 
whose superior as a steel producer does not exist 
in the United States. Compared with his achieve- 
ments, the record of the United States Steel 
Corporation makes but a sorry showing. In man- 
ufacturing, the processes and machinery are so 
complex, and the necessity for change and im- 
provement is so constant, that the ability of the 
manager is often the deciding factor in the success 
of the concern. 

Compared with the railroad, this inferiority 
of manufacturing is especially conspicuous. The 
operations of a railroad are simple and uniform. 
They repeat themselves under all conditions and 
in every section. The appliances of a railroad 
are also relatively simple, and easy to understand 
and operate. A locomotive engine is the most 
complicated machine of a railway, and the mechan- 
ism of a locomotive is relatively simple. Rail- 
roading has been called an exact science. There 
is little difficulty in filling vacancies in the most 
important positions. Railway operation is now 
largely a matter of uniform routine, coupled with 
sound judgment in financial management, and 
tact and diplomacy in conducting negotiations 

218 



INDUSTRIAL BONDS COMPARED 

with the pubHc and with the employees. The 
investor in railway bonds may justly concern 
himself with the financial management of a 
property, but he can now be confident that the 
security of his bonds will seldom be impaired by 
blunders in the operating or construction depart- 
ments. 

" The final consideration affecting the relative 
value of railway and industrial bonds, is what 
may be called the * comprehensibility ' of the 
two industries. The railroad is visible. The 
bond-buyer, it may be, rides daily over a portion 
of its lines. Its equipment and its operations are 
always in evidence. He can see the property and 
can understand its workings. This character of 
simplicity extends even to its reports. A properly 
kept railway report, to a man of average intelli- 
gence in such matters, is plain reading. The 
operations of a railway company consist in trans- 
porting a certain ntmiber of tons of freight and a 
certain number of passengers, for a certain amount 
of money. Its expenses are easily understood. 
Its equipment can be eniunerated in detail. The 
investor can follow its history from one year to 
another, and is not obliged to employ an expert 

to explain its reports to him." 

219 



THE CAREFUL INVESTOR 

'* But the manufacturing company has none of 
these advantages. Its plant is largely visible. 
A holder of United States Steel bonds might 
obtain permission to go through one of the plants, 
but he would run some risk in doing so. His 
clothing would be burned into holes by flying 
sparks. He would have to dodge locomotive 
engines running at top speed aroimd comers. 
He woiild be almost deafened by the noise, and 
often scorched by the heat. Moreover, for all 
his pains, he would understand very little of what 
he saw, and he would not care to repeat the 
experience. The ftdl report of such a company 
would be equally imintelligible to the initiated. 
What does he know about a universal plate mill, 
or a Wellman-Seaver charging machine, or a 
Jones mixer? Probably nothing. He has never 
seen these important appliances of a steel-mill, 
probably never will see them, and would under- 
stand little about them if he should see them. 
The technical jargon of an engineer's report would 
be equally imintelligible. An inventor who pur- 
chases industrial bonds buys into a company of 
whose equipment and operations he usually imder- 
stands very little. I woiild not be tmderstood to 

condemn the entire class of industrial bonds. 

220 



INDUSTRIAL BONDS COMPARED 

There are to be found bonds of manufacturing 
industries, especially those issued under the 
serial plan, where the principal is rapidly extin- 
guished out of earnings which are reasonably 
secure. The high yield of these bonds is also 
attractive. There is no reason, however, why any 
one should buy an industrial bond to yield less 
than 6 per cent., even upon the soundest recom- 
mendations and after the most careful investi- 
gation; and six per cent, with much better secur- 
ity, can be obtained from a great variety of 
investments/" 

1 Quoted from the author's Trust Finance. 



XIX 

TIMBER BONDS 

Ten years ago any first-class banking house 
in the United States wotild have immediately 
rejected a proposition to buy three or five million 
dollars of bonds secured by a first mortgage on 
standing timber. Such an undertaking would 
have been looked upon as too hazardous. The 
investor could not have been persuaded to put 
his money into such securities. 

Of late years, however, with the steady advance 
in the cost of living, and the resulting insistent 
demand for a higher rate of return on invest- 
ments, combined with the rapid development of 
financial technique in investigating opporttmities 
for investment, and in formulating plans of cap- 
italization and financial management, standing 
timber is becoming the basis of bonds which fully 
deserve the title of investment securities. 

The basis of the security in timber bonds is the 

steadily diminishing timber supply of the United 

States. The consimiption of limiber per capita in 

this country is rapidly increasing. From 1880 to 

222 



TIMBER BONDS 

1900, the increase in poptilation was 52 per cent, 
and the increase in the lumber cut was 94 per 
cent. In 1880, 18,000,000,000 feet of timber was 
cut in the United States; in 1907, 40,000,000,000 
feet. The total amount of standing timber in 
the United States, including that which is held 
by the government as forest reserve, as reported 
by the Bureau of Forestry, is 2,500,000,000,000 
feet. This supply is being exhausted at the rate 
of 100,000,000,000 feet a year, and the prices of 
all kinds of timber are steadily advancing. The 
average annual export price of lumber in 1896 
reached its lowest figure at $14.56 per thousand 
feet; in 191 1 the price of the same product was 
$21.55, ^^ increase of 48 per cent. This rapid 
increase of price is an indication of the fact that 
at the present rate of cutting, the supply of 
timber in the United States will be exhausted 
in from 20 to 25 years. The holders of timber 
land in this country possess one of the strongest 
natural monopolies, a monopoly whose value is 
certain to increase even over the present extra- 
ordinary figure. 

The successful efforts of the lumber interests 
to raise large amounts of capital by the sale of 

bonds have been prompted by the change in the 

223 



THE CAREFUL INVESTOR 

organization of the industry. Until recent years, 
the logging and milling of timber were carried 
on by two sets of producers. An accurate picture 
of the old days in the lumber industry is given in 
Stewart Edward White's "The Riverman." The 
logging firms were the owners of timber land and 
cut out a supply of logs each winter. These logs 
they would float down the river to the mills where 
they would be sold. Prices of timber land were 
low and payments were easy. Only a small 
amount of capital was required. 

This situation has now entirely changed. All 
branches of the industry are concentrated under 
a single ownership. One company owns its own 
timber lands, does its own logging and milling, 
and in some cases sells its own product. The 
amoimt of capital required to operate a business 
of this character is very large. In the first place, 
the timber holdings must be large to warrant the 
construction of a modem mill, which is a costly 
affair, and to supply it with material for an ex- 
tended period of years. The logging equipment 
now includes complete steam railways. The log- 
ging and the expense of getting out the logs is 
much greater. With the rise in the price of timber 

land, an enormous amoimt of money is tied up 

224 



TIMBER BONDS 

for a long term of years, to be collected only in 
small amounts as the trees are cut. The limiber 
operator is obliged to extend credit for periods 
up to six months. His taxes are constantly in- 
creasing, and he must meet his freight-bills and 
pay-rolls promptly. 

Few persons who are not conversant with lum- 
ber investments are familiar with the extent of 
the operations of some of these lumber companies. 
For example, one of the Southern lumber com- 
panies owns 550,000 acres of cypress and yellow 
pine, containing 3,400,000,000 feet of timber, in 
Georgia and South Carolina. This company has 
a net working capital of more than $950,000. Its 
seven mills and their equipment are valued at 
$1,250,000. In 1912 the output of this company 
was 140,000,000 feet. Another company, oper- 
ating in the far West, owns 70,000 acres of virgin 
timber lands in Western Oregon, which are esti- 
mated to contain over 4,300,000,000 feet of fir, 
cedar, and other timber. The manufacturing 
plant of this company is valued at $200,000 and 
has a capacity of 150,000 feet for each ten-hour 
day. 

In recent years it has been foimd impossible 

by the lumber companies to handle their rapidly 
15 225 



THE CAREFUL INVESTOR 

growing business with the capital derived from 
their own operations. The investment-banker 
has, therefore, been appealed to, to fiimish funds. 
The result has been the issuance of a type of bond 
which combines high-grade security with high 
interest. One bond-house in Chicago, which has 
specialized on this type of security, has already 
sold over $40,000,000 of timber bonds. 

Timber bonds are peculiar among industrial 
securities in that they are issued against property 
which already exists and which can be accurately 
measured. A bond issued on the security of rail- 
road property depends upon the continued profit- 
able operation of the railroad. A rate war, or a 
change in management, or a long-continued in- 
dustrial depression, may reduce net earnings 
below the level of fixed charges. No matter how 
costly the property of the railroad, the corpora- 
tion may be forced into bankruptcy, and the 
bond-holders suffer loss. The farm mortgage 
depends for its security upon the regular and 
profitable operation of the farm. Bonds issued 
on the security of minerals, with the possible 
exception of anthracite-coal bonds, are likely to 
be disturbed by the discovery of new supplies 

of the same mineral. 

226 



TIMBER BONDS 

The supply of timber, however, is known and 
fixed. The trees can actually be measured and 
counted. Their value is known, and that value is 
steadily increasing. All that is required, there- 
fore, to make these bonds a safe investment, is 
that they should be issued by an established com- 
pany in high credit and managed by experienced 
lumber men; that the lands should contain a 
known amount of timber of good quality, the 
exact amount to be ascertained by timber esti- 
mators employed by the banking house; that 
the titles to the land should be found perfect; 
and that the mortgage securing the bonds should 
contain provisions which will provide for the 
repayment of a certain amount of the principal 
at fixed intervals, so that, before the timber is 
exhausted, the bonds will have been paid. 

How carefully these requirements are complied 
with, in the issuing of timber bonds, may be seen 
from a recent bond offering by an important 
Boston house. The amount of the issue in this 
case was $6,000,000 of 6 per cent, bonds. These 
bonds begin to mature in July, 19 14, and are 
finally paid off in serial instalments on July i, 
1922, the instalments rising from $250,000 to 
$375,000. This is an example of the well known 

227 



THE CAREFUL INVESTOR 

plan of serial bond issues. The property of the 
company is valued at $16,800,000, or 2.8 times, 
this issue. Provision for the repayment of the 
bonds is made by a sinking fimd, which places 
in the hands of the trustees, for every thousand 
feet cut by the company's mills, $3.50. Before 
the first instalment falls due, the accimiulation 
in the sinking fund will amount to $250,000. As 
a result of the operation of this sinking fund, the 
margin of security for the investor is steadily 
increasing. At the outside, the bonds will repre- 
sent $1.76 per thousand feet of standing timber. 
This will be reduced, by the operation of the 
sinking fund, to $1.40 per thousand feet on 
January i, 1917, to 89 cents per thousand feet on 
July I, 19 1 9, and to 27 cents per thousand feet 
of standing timber on July i, 1921. 

This company operates in a district which has 
never been disturbed or seriously damaged by 
fire. The mortgage securing the bonds provides 
that the saw-mills and manufactured lumber shall 
be fully protected by fire insurance. The Com- 
pany has been in successful operation for 40 years. 
It is managed by men experienced in timber invest- 
ment and saw-mill operations, who own practically 
the entire capital stock of the company. The 

228 



TIMBER BONDS 

proceeds of the issue are employed for additional 
working capital and to increase the timber re- 
serves. The net earnings of the company for the 
present year are estimated at $1,000,000, as com- 
pared with the interest requirement on the bonds 
of $360,000. 

These statements are made by the banking 
house on the basis of a careful investigation. 
The bankers themselves verify the statements 
made on behalf of the management as to the 
history of the company, and the standing of those 
in control of it. For the financial results of the 
operation, the bankers rely upon the examination 
of chartered accountants. The report of these 
accountants they submit in connection with the 
offering of the bonds. In this case, the account- 
ants* report showed that the average manufac- 
turing profits for the past 6 years have been 
$5.81 per thousand feet of lumber sold. 

The most important investigation made on 
behalf of the bankers is the amount of standing 
timber. This report is signed by Mr. W. E. 
Straight, one of the leading timber experts in 
the United States, whose name on a report is 
positive proof of a thorough preliminary examina- 
tion. The method employed by Mr. Straight is 

229 



THE CAREFUL INVESTOR 

described in a booklet issued by Messrs. Clark L. 
Poole & Co. of Chicago, one of the leading bank- 
ing houses in this line, in part as follows : 

All comers having been established, Mr. Straight assigned 
the crews to work. They were started at different points and 
worked to a common centre, with the intention to have all the 
crews meet about the same time. Each crew is furnished with 
plans of the different portions of the land allotted to it, the 
descriptions all being checked from the original deeds to the 
property. ... A camp will be occupied on an average of 
about ten days; and the crews wiU cover from lo to 17 sections 
of land from one camp, depending on the character of the coimtry. 

Each crew covers on foot the several portions of the woods 
assigned to it. The crew starts at some point on the base given 
by the surveyor and continues to do its work, keeping an accurate 
check on its base as the work proceeds. The method used is 
known as "horse-shoeing a 40," and is the one most commonly 
used by Mr. Straight, as it enables the cruiser to see every por- 
tion of the land. If the start is made at the southeast comer of 
a section, the cruiser will say to his compassman: "Go to tally 
I north," When the compassman, who nms all the lines, has 
gone north 125 paces, or about 375 feet he calls out: "Tally i 
north," and stops imtil he is directed to move. This gives one 
side of a ten-acre tract. 

The cruiser has begim to work toward the compassman, and 
counts and estimates each and every tree for a distance of 25 
paces on each side of his base line, making 50 paces in all. At 
first he measures the trees with a tape, to verify his eye judgment 
of the circiimference and meastires windfalls for length to verify 
his eye judgment as to the height of trees. If his eye judgment 
has been at fault, he keeps measuring untU his eye judgment 
becomes accurate, then he trusts solely to his eye. He keeps 
tally of each tree, and at the close of the day figures out his totals 
by an established mathematical nile. . . . When the esti- 

230 



TIMBER BONDS 

mator has finished his work ... he has an accurate tally 
of each tree on eight acres of each 40 acres, with its length and 
other dimensions. In his hand he has held a card on which he 
has kept a tally. He also carries a field book in which he notes 
the topography of the land, the location of marshes, lakes, streams, 
wagon loads, logging railroads, and everything that comes within 
his observation, together with notations as to the surface of the 
ground, general logging chance, character of soil, etc. At night 
he makes out from his field book an accurate plat, or timber 
section and field report sheet, one for each section of land esti- 
mated. 

It is on the basis of carefully detailed work of 
this sort, carried on under the direct supervision 
of the supervisor, that the banking house esti- 
mates the quantity of timber on which it advances 
money. When this estimate is supplemented by 
a verification of details, and by the drawing of a 
trust deed conveying the timber and all other 
property of the company, in trust for the pay- 
ment of principal and interest of the bonds, under 
a variety of carefully drawn restrictions which 
practically eliminate the risk of careless financial 
management, the banking house can offer the 
investor a 6 per cent, bond which is as safe an 
investment as can be furnished him. 



XX 

INDUSTRIAL PREFERRED STOCK 

Every part of the United States is the seat of 
old and prosperous manufacturing enterprises, 
many of them dating back to the middle of the 
last century, with long records of solvency and 
profit. Fifteen years ago, when the industrial 
trust movement started, a large number of these 
concerns were swept into consolidations, and their 
owners seized the opportimity to retire. This 
industrial trust movement, however, was aimed 
not at the investor, but at the speculator. The 
stocks of these much-criticised combinations were 
not sold by investment-bankers to their clients, 
but were marketed on the public stock-exchanges 
by the methods of public advertising and manipu- 
lation. For a long time the investor would have 
nothing to do with them. 

Following the collapse of the consolidation 
movement, about 1903, the flotation of industrial 
preferred stocks languished, and not imtil the 
last three years has this class of securities seri- 
ously engaged the attention of the financial world. 

232 



INDUSTRIAL PREFERRED STOCK 

This time it is not the speculative promoter who 
creates the new issue, but the investment-banker, 
anxious to satisfy the insistent demands of his 
clients for a security which will furnish them 
reasonable safety with a higher rate of return 
than they can secure from the purchase of bonds. 
The result has been a large nimiber of preferred 
stock issues covering every kind of business. 
Agricultural machinery companies, canning com- 
panies, biscuit companies, clothing companies, 
automobile and trading companies, have all con- 
tributed to supply the now enormous total of 
these industrial preferred stocks. 

The usual investigations are made by the 
banker in marketing these securities. If he is 
conscientious, however, he does not recommend 
them in the same unqualified terms as those which 
he employs in advocating the purchase of a mort- 
gage bond. The policy of one very large house 
is to discourage the sale of preferred stocks to 
the small investor. It recognizes that there is 
an element of speculation in these securities. 
They must be classified as speculative invest- 
ments. There are few manufacturing enterprises 
which are sufficiently prosperous to guarantee 

seven per cent, to the investor in good times and 

233 



THE CAREFUL INVESTOR 

bad. Those who purchase these securities must 
take the risk of business depression, from which 
the holders of well selected bonds are now neariy 
immune. 

The banker does his best to protect his client 
who buys preferred stock, by inserting in the 
contract, under which the preferred stock is 
issued, a variety of restrictions, all of which are 
calculated to secure the investor. Preferred 
stocks are now imiversally made cumulative as 
to dividends, and also as to assets. By this 
provision, in case a period of depression should 
force the management to pass the dividend for 
one year, this unpaid dividend must be made up 
before the common stock-holders can receive any- 
thing. There is also a preference as to assets in 
the event of liquidation. In the unlikely event 
that the company should desire to dissolve, 
realize on its property, and distribute the pro- 
ceeds, the preferred stock-holder would be paid 
first. 

An effort is made, also, to enforce conservative 

financial management upon the company. It is 

almost universally provided that no mortgage 

can be placed upon any of the property held by 

the company without the consent of the holders 

234 



INDUSTRIAL PREFERRED STOCK 

of three-fourths of the preferred stock. In some 
cases the company is prohibited from issuing 
bonds of any kind, whether secured by mortgage 
or not, which would rank ahead of the preferred 
stock, maturing more than one year from the 
date of issue. Some restrictions require the com- 
pany to set aside a sinking fund out of earnings 
before any dividends are paid on the common 
stock, and to retire a certain portion of the pre- 
ferred stock each year. Again, it is frequently 
provided that the quick assets — cash, good ac- 
counts receivable, materials and suppHes, and 
half finished and finished products of the com- 
pany — ^must at all times equal the amount of 
preferred stock outstanding. 

If these requirements are not carried out by 
the directors, in addition to the penalty of a 
prohibition on common stock dividends, it is 
sometimes provided that the exclusive voting 
power shall vest in the preferred stock-holders, 
who are placed in control of the company until 
the provisions of the contract have been com- 
plied with. These restrictions are excellent. 
They are calculated to secure the investor. They 
cannot, however, impart to preferred stock the 

security of a mortgage bond, secured not only by 

235 



THE CAREFUL INVESTOR 

earnings but by properties specifically set aside 
for its protection. 

Even with all these safeguards and restrictions, 
preferred stock ranks after all forms of indebted- 
ness. Its dividends are payable only when earned, 
and then at the discretion of the directors. It 
ranks ahead of common stock, it is true, but dur- 
ing periods of depression, or in case the directors 
pursue an imwise policy, involving the company 
in financial embarrassment, the holders of the 
preferred stock must be prepared to stand the 
loss. They must recognize that they are not 
creditors of the company, but merely owners; 
that in any final adjustment or liquidation of the 
company's affairs the creditors' claims must first 
be satisfied, and the preferred stock-holders must 
take what is left. 

A melancholy example of misfortune of this 
character is furnished by the fate of the McCnmi- 
Howell Company, a corporation engaged in the 
manufacttire of radiators, boilers, and enameled 
ware, which in 1910 made a large issue of pre- 
ferred stock for the ptirpose of acquiring control 
of companies manufacturing vacuum-cleaners and 
other appliances. 

I have before me the circular issued by the 
236 



INDUSTRIAL PREFERRED STOCK 

fiscal agents under date of November i, 1910, 
and containing a variety of information which 
was then believed to be accurate, but which sub- 
sequent events proved was not correct. The 
assets of the company amotmted to $7,425,685, 
according to this statement. Against these assets, 
there was no debt. The liabilities included 
$3,500,000 of common stock and an equal amotmt 
of cimiulative preferred stock, a surplus of $333,- 
185 and a reserve of $92,500. The charter of the 
company provided that no bonds could be placed 
upon the property of the company except with 
the consent of the total outstanding stock. The 
proceeds from the sale of this preferred stock 
increased the net working capital of the company 
to $2,408,597, which, it was stated, "provides 
the company with ample working capital to care 
for its increasing business." The accotmts of 
the several companies, it is stated on the authority 
of '* chartered accountants," show net earnings of 
$640,195, over two and one-half times the divi- 
dend requirements on the entire issue of preferred 
stock. Dividends of 3 per cent, were being paid 
on the common stock. As a result of the consoli- 
dation, large increases in earnings were expected. 
One of the banker's circulars concluded as follows : 
237 



THE CAREFUL INVESTOR 

From the standpoint of security, stability of earnings, liberal 
income return, marketability, and promise of appreciation in 
value, we regard the above stock as a safe and attractive invest- 
ment. Our recommendation is based on our own intimate knowl- 
edge of the affairs of the company for the past five years. 

This issue was offered by a number of banking 
houses to their clients. It is presumed that they 
made proper investigations into the affairs of the 
various companies, and that they had confidence 
in the merits of the scheme. Certainly the issue, 
although not as good as some others, was, on the 
face of these statements, of a very good quality. 
The new company had no debts. Its earnings 
were equal to two and one-half times the pre- 
ferred dividend requirements. With a prospect 
of large increases in those earnings, the investor 
could be reasonably certain that his preferred 
dividends would be regularly paid, or that, in case 
it proved necessary to suspend these dividends, he 
would risk nothing more than a postponement of 
his income. This was on November i, 1910. 

Sixteen months later we find the following 
news item: 

Justice Buffington, in the United States District Court at 
Philadelphia, appointed Edward R. Stettinius, President of the 
Diamond Match Co., and Walter D. Updegraff, of Philadelphia, 
receivers, on application of A. F. Pfahler of Philadelphia, who, 
it is said, owns $310,300 stock. The company agreed to the 

238 



INDUSTRIAL PREFERRED STOCK 

receivership, but declared that inability to realize on assets, and 
not insolvency, was the cause of its troubles. 

The bill alleges that the company is perfectly solvent, but 
that a reorganization is necessary ; that the company has suffered 
extremely in the last six months from a sudden contraction in 
trade, due in great measure to the Government's suit against the 
"bathtub trust," which also hurt the company's credit. There 
is said to be outstanding about $1,800,000 in commercial paper 
in the hands of many parties, maturing within the next four 
months, of which $300,000 matures before March 31, and "quick" 
assets in excess of commercial paper which cannot be turned into 
money to meet obligations. The liabiHties are stated to aggregate 
$2,11 8 ,000, and the quick assets $ i , 749 ,000, consisting of accounts 
receivable, $1,480,000; bills receivable, $219,000, and cash, 
$50,000. 

On September 27th we have another news 
item — the report of the receivers. In place of 
temporary embarrassment, we now find revealed 
a condition of absolute bankruptcy. Mr. Albert 
H. Wiggin, Chairman of the Creditors' Commit- 
tee, says in substance: ''Oiir investigations have 
convinced us that if the property be disposed of 
at a forced sale, the creditors can realize but a 
small percentage of their claims. The business, 
however, appears to have an earning power. Mr. 
Strong estimates the earnings, after making cer- 
tain improvements, at $209,000 a year, with a 
gradual increase. Others name higher figures." 

The receivers presented at this time a statement 
of assets, in place of the $7,425,685 set forth in 

239 



THE CAREFUL INVESTOR 

the letter of the president of the company, "sub- 
mitted and verified by the Safeguard Account 
Company, Chartered Public Accoimtants," to 
the amoimt of $2,179,361, a shrinkage of $5,200,000 
in two years and three months. The liabilities 
of the company, which were so clear and clean 
two years before, now present a melancholy 
spectacle. They include accounts payable, $326,- 
647; bills payable, $2,047,053; endorsed or guar- 
anteed paper, $212,693; a total of $2,586,394. 
And in addition there were over $700,000 of 
unproved claims. The receivers further say: 
**The company originally manufactured boilers, 
radiators, enameled bath-tubs, lavatories, etc., 
but early in 19 10 adopted a policy of expansion, 
to which its embarrassment is largely attributable. 
None of these purchases proved profitable; the 
portable vacuum-cleaner business resulted in 
heavy losses." 

One last news item completes the story. 

Justice Buffington in the United States District Court in 
Philadelphia, on November 13, 1912, affirmed the sale of the 
assets and property of the company, to a committee representing 
the creditors, for $870,000 cash. The offer was made two weeks 
ago, over 80 per cent, of the creditors having consented thereto. 
The reorganization wiU be effected at once. 

I do not claim that this disaster which elimi- 
240 



INDUSTRIAL PREFERRED STOCK 

nated $3,500,000 of preferred stock, into which 
large investors had put their money, and de- 
stroyed a large common stock equity, is typical 
of what will befall other industrial corporations 
which have put out their securities on the strength 
of banker's recommendations and seven per cent, 
dividends. This case is, no doubt, exceptional. 
It does, however, show how quickly the aspect 
of prosperity may be changed by unwise financial 
management, and especially by a rapid increase 
in debt. The preferred stock-holder is powerless 
to prevent such a catastrophe. Even though his 
contract with the company prohibits the directors 
from issuing any evidences of debt maturing in 
more than one year, they cannot be restricted in 
making bank loans or in buying merchandise 
on account. 

I have before me a list compiled by a large 
financial institution, of the notes and paper of 
various industrial corporations outstanding at 
various dates in 191 1 and 191 2. The totals in 
some cases are very large and are rapidly increas- 
ing. These floating debts represent a constant 
menace to the solvency of these companies. They 
carry a threat of receivership and foreclosure sale 

which the stockholder cannot disregard. When 
16 241 



THE CAREFUL INVESTOR 

the directors, therefore, propose an issue of bonds 
or notes to fiind these floating debts, the stock- 
holders can do nothing less than to consent. 
To refuse their consent is to invite disaster. 
What, then, becomes of this much vaunted re- 
striction as to note issues and mortgages? It is 
valueless in the face of such a situation. 

A large corporation, with a record of over sixty 
years of continuous growth, a little more than a 
year ago issued $8,000,000 of preferred stock, 
with the usual restrictions for the protection of 
the preferred stock-holders. The total accoimts 
and bills payable of this company were, in roimd 
numbers, $2,700,000, with a siuplus of assets over 
current liabilities of nearly $19,000,000. A few 
months later this company announced a large 
issue of notes for the purpose of refunding its 
floating debt. These notes come ahead of the 
preferred stock, and there is no way in which 
the holders of the preferred stock can prevent 
their issue. 

I would not be understood to condenm indus- 
trial preferred stocks. They should be character- 
ized as speculative investments. Most of them 
will, no doubt, continue to pay regular dividends. 
But such securities should be purchased only 

242 



INDUSTRIAL PREFERRED STOCK 

from the most reliable banking houses, who will 
stand back of the issue, and who will not hesi- 
tate to use their great power as fiscal agents of 
the company to prevent unwise and extravagant 
management, and the departure from lines of 
policy whose wisdom has been proven by the 
experience of long success. The purchaser of 
such stocks must also realize that he is taking a 
risk; that seven per cent, is not compatible with 
an assurance of absolute safety, and that in the 
event of a recurrence of industrial depression he 
must be prepared to submit to a postponement 
of his dividends. 



XXI 

THE DISSOLUTION OF THE TRUSTS 

Judgment day for the trusts has arrived. Some 
of them, we hope, are good, and some of them are 
evil. The federal courts are now, and will be for 
a long time, occupied in separating the sheep 
from the goats. The Supreme Court, in the Oil 
and Tobacco cases, has set up a standard by 
which to decide which of these great companies 
is lawful, and which must be dissolved. 

The opinion of the court is clear that any cor- 
poration engaged in interstate commerce (which 
includes all the trusts), and which has been formed 
not ''with the legitimate purpose of reasonably 
forwarding personal interest and developing trade, 
but on the contrary were of such a character as to 
give rise to the inference or presumption that they 
had been entered into or done with the intent to do 
wrong to the general public, and to limit the right 
of individuals, thus restraining the free flow of 
commerce, and tending to bring about the evils 

such as enhancement of prices which were con- 

244 



THE DISSOLUTION OF THE TRUSTS 

sidered to be against public policy," is unlawful 
under the Sherman Act. 

The court says, in effect, that any large com- 
pany or collection of companies, formed with 
the purpose of limiting competition, that is ad- 
vancing or keeping up prices, or which, after its 
promotion, uses its power to limit competition, 
so that prices can be advanced, is an unlawful 
organization and must be dissolved. In the light 
of these decisions the legal position of the large 
companies formed in the last twenty years, to 
put together sometimes thirty smaller concerns 
which had been competing with one another, is 
very doubtful. Most people who own securities 
of any kind have the preferred or common stocks 
of these industrials. There are large companies, 
all organized on the model of the Standard Oil 
Company, whose stock prices appear in the daily 
New York quotations. If the movement against 
the trusts continues, all these hundreds of thou- 
sands of stock-holders — the Steel Trust alone has 
over 100,000 — ^must adjust themselves to new con- 
ditions. Until this adjustment is made, or so long 
as the fear of it is present, what we call prosperity 
will not return. 

How will this adjustment be made? How can 
245 



THE CAREFUL INVESTOR 

the trusts be dissolved, in such a manner as the 
court says, "to protect, not to destroy, rights of 
property? " A word about the organization of the 
trusts. Here are five corporations. A, B, C, D, 
and E, making shoes, or steel, or pimips, or 
harvesting machinery. These companies are 
competitors; they are constantly fighting one 
another — ^raiding one another's customers; cut- 
ting prices, secretly and sometimes openly; mak- 
ing agreements, gentlemen's agreements, and then 
breaking them ; stealing or corrupting one another's 
employees; biting and clawing each other in the 
bear-pit of competition; behaving like mediaeval 
captains of brigands instead of modem captains 
of industry. The men who control these com- 
panies decide to combine and so stop the waste 
of competition. 

Suppose, for the sake of simplicity, the stock 
of each of these five companies is $2,000,000, each 
share having a face value of $100. A New Jersey 
corporation is organized, which issues $20,000,000 
of stock — $10,000,000 preferred and $10,000,000 
common. The preferred stock is entitled to 
receive $700,000, seven per cent., before anything 
is paid on the common. The consolidation is 
now formed by the exchange of one share of pre- 

246 



THE DISSOLUTION OF THE TRUSTS 

ferred stock and one share of common stock of 
the New Jersey corporation for each of the 100,000 
shares of the five companies. The New Jersey 
company — ^let us call it the Amalgamated Com- 
pany — now owns $10,000,000 of the five companies 
and their former stock-holders own $10,000,000 
of the preferred and common stocks, $2.00 for 
$1.00 of the stock of the five companies — an 
operation familiar to most people as stock watering. 
Immediately price-cutting, misrepresentation, 
slander, back-biting, everything that goes under 
the name of cut-throat competition, is at an end 
between them. The Amalgamated Company is 
the sole owner of all five, electing directors, choos- 
ing officers, establishing prices, driving these five 
tamed animals to one vehicle and in one set of 
harness. Every feature of the business policy is 
now reduced to rule and order. The territory 
over which, as competitors, all were accustomed 
to raid and foray, is divided among them. One 
of the five plants may be out of date, badly located. 
Its business is divided among the other four. The 
general administration is centred in New York; 
financing, buying, advertising supervision, all are 
managed from a central office. In place of war, 

concord, peace, and harmony succeed within the 

247 



THE CAREFUL INVESTOR 

circle of these former rivals. The new company 
may not advance prices, but it gets from the 
customer those prices which it publishes; every 
one pays the same prices. There are no rebates, 
no special discounts, no allowances. 

This, in brief, is the change which was accom- 
plished by the organization of the trusts. There 
is a darker side to the picture. Stories and sworn 
statements of the wrongful and oppressive use 
of the great power of these great corporations are 
nimierous. Business, however, is not conducted 
to the strains of soft melody. At best, some of 
its practices are not pretty. Probably the two 
culprits did no more, nor as much, against the 
moral law, when their enormous size is considered, 
than the average grocer or milkman. In passing, 
it may be observed that in the grocery trade, to 
quote but one instance, there are three prices for 
the same coffee done up in different packages. 

The Supreme Court did not, however, heed 
these charges. It passed them over. To arrive 
at the conclusion that the Standard Oil and the 
American Tobacco Companies should be dis- 
solved, it was not necessary to inquire whether 
these companies were benevolent despotisms. 
That they were, or aimed to be, supreme in their 

248 



THE DISSOLUTION OF THE TRUSTS 

respective fields, was sufficient to condemn them, 
and to condemn any other company which by the 
consolidation of competitors has reached a posi- 
tion similarly exalted. 

Since the Standard Oil Trust has passed out 
of existence, a word in its favor may be more 
favorably received than when it was alive. De 
mortuis nihil nisi bonum. 

One of the undisclosed abuses in the railway 
industry is the open violation by many shippers 
of the classification rules of the railroads. There 
are five classifications into which falls every com- 
modity save such as are carried on special rates, 
like coal and lumber. The rates are highest on 
Class I, and fall to Class V. The basis of dis- 
tinction between these classes is the cost or risk 
to the railroad in shipping them, together, in 
some cases, with the value of the article. An 
article which is carefully boxed or crated will 
take a Class III rate, while if it is not protected 
from breakage, it will take a Class II rate. 

There was a liveryman in an Iowa town who 
needed a carload of horses. Emigrant movables, 
including furniture and live stock, take a very 
low rate. The railroads seek to encourage settle- 
ment. Horses take a high rate. Our friend was 

249 



THE CAREFUL INVESTOR 

familiar with these facts. He went to Montana, 
bought his horses, loaded with them into a car 
two kitchen-chairs, an old stove, and some 
domestic bric-d-brac, and billed the whole as 
"household movables." Another enterprising 
shipper also billed the following articles as house- 
hold movables: portable forge, 2 sinks, i bundle 
rakes, i wire gate, 6 loose sledges, i barrel lan- 
terns, 2 wheelbarrows, i box pipe-fittings, 200 
reels of barb wire. These cases are not excep- 
tional. More than a thousand are reported daily 
in New York City alone. Each offense is pimish- 
able by fine or imprisonment, or both, at the 
discretion of the court. 

To detect these misdescriptions, the railroads 
maintain inspection bureaus, whose inspectors 
are constantly on the alert to raise the freight on 
way-bills incorrectly made out. Nothing else is 
done. Until recently the Interstate Commerce 
Commission has not been willing to act in the 
matter. Why should the railroads concern them- 
selves with the enforcement of the law. Chicago is 
one of the centres of misdescription. The inspectors 
are constantly on the watch to detect violations 
of the law and to raise the rates. The list of 

habitual offenders is long, and contains some 

250 



THE DISSOLUTION OF THE TRUSTS 

honored names; but the name of the Standard 
Oil Company of Indiana is not among them. An 
official of one of the inspection bureaus told me 
that in a service of thirteen years not one of his 
inspectors had ever reported even a minor infrac- 
tion of the rules by the Standard Oil Company. 
Let us consider another instance of a different 
kind. When a man or a corporation has some- 
thing to sell, he or it can usually be relied upon 
to put a high value upon it. Sometimes, even 
when the sellers are very conservative, the value 
is excessive. A large public-service company, 
owning plants in many cities, recently arranged 
to purchase a gas company owned by the Stand- 
ard Oil Company interests, and managed ac- 
cording to Standard Oil methods. In the schedule 
of assets submitted for the consideration of the 
buyers appeared this item, "Securities owned, 
$200,000.'* The president of the ptu-chasing com- 
pany pounced instantly upon this. He became 
suspicious. He resolved to investigate. He had 
experience with ** Securities owned." He knew 
how worthless they might be. He asked the 
vendor's attorney for a list of these ** securities." 
The attorney said, * ' They are all bonds. " " Bonds 

of what?** "United States Government Bonds,*' 

251 



THE CAREFUL INVESTOR 

was the answer. The gas company had put aside 
a large amount out of its earnings in the safest 
securities in the world. 

These old-fashioned business virtues of strict 
obedience to the laws of business, caution in pay- 
ing out profits, prompt payment of bills, accurate 
accounting and bookkeeping, avoidance of debt, 
fair and honorable treatment of employees, main- 
tenance of high standards of product — ^virtues for 
which the Standard Oil Company has always been 
distinguished — are, of course, not to be weighed 
in the balance against "the intent and piupose 
to maintain the dominion over the oil industry"; 
but they are at least not so common even among 
the critics of the company as to pass unnoticed. 
Indeed, the possession and recent practice of 
these virtues by certain men prominent in the 
magazine field would have saved them control 
of their properties which have passed into other 
hands. Let us hope that with the breaking up 
of the Standard Oil Company there will be a 
general diffusion of certain of its principles and 
business methods in quarters which now know 
them not. 

These trusts, by the mandate of the court, are 

now being dissolved. The method which has been 

252 



THE DISSOLUTION OF THE TRUSTS 

followed in each dissolution is to distribute the 
assets of the New Jersey companies among their 
stockholders. Take the case assumed above, for 
example. The Amalgamated Company has issued 
100,000 shares of preferred and 100,000 shares 
of common stock. It has in its treasury 100,000 
shares of the stocks of the five companies. On 
these stocks it has been collecting dividends and 
paying out these dividends to its own stock- 
holders. The court now orders this company to 
dissolve. It adopts the method, so called, of a 
pro rata distribution of assets. Each of the five 
companies changes its charter so as to turn 50,000 
shares of common stock into 50,000 shares of 
preferred stock, still in the hands of the New 
Jersey company, the Amalgamated, the sole 
owner of all the shares. Then for each share of 
its preferred stock the Amalgamated gives one- 
fifth share of the preferred stocks of each of the 
five companies, and for each share of its common 
stock it gives one-fifth share of common stock in 
each of the five companies. The Amalgamated 
Company can now be dissolved. Its stock- 
holders have all of its assets. For all practical 
purposes, it has ceased to be. The ^ve original 

companies remain, but now, instead of their 

253 



THE CAREFUL INVESTOR 

ownership and control being in the hands of the 
Amalgamated Company, they are owned, it may 
be, by i,ooo individuals holding from 5 to 1000 
shares each. This method with some variations 
has been applied to dissolve the Oil Trust, the 
Tobacco Trust, the Powder Trust, and all the 
rest of the condemned. 

Now comes the rub. Cut-throat competition 
is bad. This is generally recognized. Mr. Andrew 
Carnegie was the last apostle of the old com- 
petitive regime, and he passed out of business ten 
years ago. For several years Mr. Elbert H. Gary 
has been conducting a school of cooperation for 
iron and steel products. His classes have been 
largely attended, and the lectiires have been both 
interesting and instructive. At the last session 
of the class in cooperation, held at the Waldorf- 
Astoria on May 29, 191 1, Judge Gary stmimed 
up the objects and results of the course as follows : 

Whatever we do with reference to prices, whatever we may 
decide is necessary in order to protect our interests on this occa- 
sion and under these circumstances, in my opinion it is highly 
important for the long future that we continue our relations of 
friendship and open and frank expression with reference to what 
we are doing. Now, I do not know the feeling of the rest of you. 
I do not know what you are disposed to do. I think that so far 
as we are concerned we would be largely influenced by the action 
of others, and while insisting upon the position from which I 

254 



THE DISSOLUTION OF THE TRUSTS 

have never varied, I would not, under any circumstances, make 
any agreement, expressed or implied, direct or indirect, to main- 
tain certain prices, to keep away from customers, to divide terri- 
tory, to restrict output, or to make any agreement of any sort 
or description with you or any of you, because, as I understand 
the law, I have no right to do it; yet at the same time I would 
do what I have always said I would do; I wotild tell you and 
each of you at any time exactly what we are doing; I would give 
you the names of our customers; I would tell you what prices 
we were charging; I would give you any information concerning 
our business, concerning our mills, concerning our clients, con- 
cerning ourselves, that you wanted'to have, so long as you have 
the same disposition toward me. 

Competition should relate to standards of prod- 
uct, to promptness of delivery, to service, and 
should not refer to price. Railroads compete 
furiously for passenger business, yet they do not 
cut rates. They merely increase the speed and 
comfort of their trains. Price-cutting in any 
trade qtiickly leads to demoralization. It destroys 
confidence, makes cooperation impossible, leads to 
deterioration in quality, and makes business uncer- 
tain and hazardous. Again, quoting Judge Gary: 

There is only a certain amount of business. You can get it 
away from your friend for a day or a week ; perhaps you can make 
a contract for a time and get a particular order; but in the long 
run, on the average, month by month, year by year, you cannot 
get and keep his business. 

Granting the evils of competition in prices, 

and the superiority of cooperative methods in 

255 



THE CAREFUL INVESTOR 

business, the fact remains that the temptation to 
cut prices in dull times in order to get business 
from competitors is almost irresistible. The 
buyer, taking naturally and without effort the 
role of Satan, shows the seller a promised land 
of profitable contracts, new business, future con- 
nections, if only the seller will cut the price. 
Times are hard, business is slow, debts are press- 
ing. It is almost too much to expect of a man of 
small calibre that he shall set his face like a flint 
against the blandishments and alluring induce- 
ments of the buyer. And yet, if he yields, the 
evil spirit of price-competition, accompanied by 
seven other devils, will return to the house from 
which the trust movement expelled him, and the 
last state of American business will be worse 
than the first. 

Here lies the danger to the prosperity of the 
United States in the dissolution of the trusts. 
Broken up, as they will be, into a thousand small 
companies, strictly forbidden to combine, each with 
its separate officers, its own board of directors, can 
ruinous competition be prevented? Will these 
directors and officers be big enough to adhere to 
the prices published by the leaders in the trade, 

and, so far as the law allows, will they cooperate 

256 



THE DISSOLUTION OF THE TRUSTS 

for mutual benefit by disclosing to one another 
their lists of customers and the terms on which 
they do business? If the American business man 
can rise to the emergency presented by the dis- 
solution of the trusts, the decisions will prove to 
have been of great benefit. 

For there is another side to the trust picture, 
a side which is by no means attractive. Large 
aggregations of widely scattered plants, managed 
by hired men, supervised by directors who repre- 
sent thousands of stock-holders with no other 
interest in the industry than to get their divi- 
dends, cannot be managed with the same energy, 
efficiency, and economy as smaller industrial 
units can be handled. The cost of production of 
the trusts, speaking broadly, is far above the cost 
of the best plants which went into the trusts, 
although it is lower than that of the poorest 
plants. An intelligent, energetic group of partners 
or stock-holders, with ample capital, operating 
a single plant, can produce at lower cost than can 
a large and scattered aggregation of plants man- 
aged by hired men, no matter how intelligent 
and conscientious. 

In conversation recently upon the subject of 
centralized management, a well known engineer 
17 257 



THE CAREFUL INVESTOR 

cited his own experience in managing a group of 
public-service corporations from a New York 
office. Daily reports were forwarded to him from 
each company, and he was in instant touch with 
every emergency. He foimd, however, after a 
series of costly experiments, that the plan would 
not work. Mistakes would occur which he would 
correct, but the mistakes could not be antici- 
pated or the resulting losses prevented. He was 
eventually compelled to abandon the system of 
centralized management, and place each company 
upon its own footing, with its own responsible 
head. 

In so far as the trusts are concerned, it is a 
simple matter to prove that these "economies 
of combination" are largely imaginary. It will 
be recalled that, in organizing our hypothetical 
combination, preferred stock in the Amalgamated 
Company was given share for share to the stock- 
holders of the five companies that went into the 
combination, and also an equal amount of com- 
mon stock. This common stock, in most cases, 
was "water"; that is to say, it did not represent 
any value in existence. It was supposed to repre- 
sent the "economies of combination." Each of 
the five plants was worth $2,000,000 before the 

25S 



THE DISSOLUTION OF THE TRUSTS 

trust was formed. By putting them together, 
destroying competition among them, reducing 
unnecessary expenses, and with the advantages 
of high-grade management, this value, it was 
assumed, would be increased to $4,000,000, or 
the value of the five from $10,000,000 to $20,000,- 
000. This plan was followed in nearly every case. 

Now, if we wish to discover the value and extent 
of these "economies," it is only necessary to look 
at the quotations of these common stocks. Most 
of the trusts have been in existence eight years or 
more, and the period of their life includes some 
of the most profitable years in the history of 
American industry. They have had plenty of 
time to realize these economies. If there is a 
basis for the organization of consolidations of 
numerous plants, managed by a board of directors 
in New York, the common stocks, which repre- 
sent the "economies of combination" — the sav- 
ings from buying in large quantities, the lower 
rates of interest paid to the banks, the superior 
talents of high salaried men, along with the 
admitted gains from stable prices — would appear 
in high dividends and high prices for the stocks. 

And yet we find such quotations as these, 
representing the percentage of $100 per share, 

259 



THE CAREFUL INVESTOR 

at which the trust common stocks are now selling : 
Allis Chalmers, g}4\ American Beet Sugar, 39^^; 
American Agricultural Chemical, 46; American 
Can 8% ; American Car and Foundry 50^ ; Ameri- 
can Locomotive, 35^; and so on. There are a few 
exceptions, but for the most part, so far as the 
market quotations of the trust stocks are con- 
cerned, the "economies of combination" do not 
exist. It is possible that the United States has 
paid too high a price in an industrial development 
arrested by the stagnant routine of monopoly 
for the benefits of suppressed competition. 



XXII 
THE INVESTOR AND GOLD SUPPLY 

In a series of articles recently published in 
Cotton and Finance^ dealing with the subject of 
gold production and its effe;ct upon the prices of 
bonds, stocks, and commodities, Mr. Theodore 
H. Price reaches a conclusion which, if it can be 
established, is of vital moment to every owner of 
property in the United States, whether that 
property be bonds, insurance policies, stocks, or 
real estate. This conclusion, briefly stated, is 
that the increasing production of gold is respon- 
sible for the great rise of prices which has been 
the characteristic feature of the last decade; that 
this increased production of gold will continue 
indefinitely; and that the world is facing an 
economic crisis arising out of the certainty of a 
persistent depreciation in its standard of value. 

This subject has been much discussed in recent 
years, as the steady rise of prices has brought 
home to every class in the community the im- 
portance of the problem presented. The fact of 

the advance of prices is well established. In 1896 

261 



THE CAREFUL INVESTOR 

Bradstreet's compilation of the wholesale prices 
of 1 06 commodities, including all the leading 
commodities of commerce, was 59,124. In 1900, 
this figure had risen to 78,839; in 1905, to 80,987; 
and in 1912, to 90,362. Specimen increases in 
particular commodities are even more striking. 
For example, the price of wheat, during this 
period of seventeen years, rose from 64 cents to 
$1.22 ; the price of com, from 33 cents to S6 cents; 
the price, of beef cattle, from 4.6 cents to 9 cents; 
eggs, from 12 cents to 20 cents; raw cotton from 
7 cents to II cents; anthracite coal from $4.25 
to $5.50; and so on, with hardly any exception, 
throughout the entire list. This rise of prices is 
mainly responsible for the high cost of living. 
The advance of prices is lessening the purchasing 
power of gold over the necessaries of life. 

The competition of corporations for the money 
of the investor, on the other hand, because of the 
rapid multipHcation of companies, and the nimier- 
ous safeguards which its experience and informa- 
tion is teaching the bankers to throw about the 
stocks and bonds which they offer for sale, is 
growing constantly sharper, and is forcing down 
the prices of all securities which carry a fixed 

income, and which have no prospect of sharing 

262 



THE INVESTOR AND GOLD SUPPLY 

in increasing profits. The investment fund, it is 
true, is steadily increasing, but since the pur- 
chasing power of a 4 per cent, or 5 per cent, 
investment income is so rapidly declining, while, 
at the same time, the nimiber of securities offering 
these rates of interest is increasing, the natural 
result is that the investor discriminates against 
so-called "gilt-edge" bonds. This depreciation 
in the prices of bonds, while apparently it is an 
advantage to investors making new purchases, is 
threatening heavy losses to the owners of invest- 
ments already in existence. 

Few realize to what an enormous total the 
securities of bonds and stocks issued by American 
corporations has moimted. In an article by 
Francis Lynde Stetson, published in the Atlantic 
MorUhly for July, 1912, which is quoted by Mr. 
Price, the following statement is made : 

In the fiscal year 1909, according to the report of the Commis- 
sioner of Internal Revenue, there were in the United States 
262,490 corporations of all kinds, with more than $84,000,000,000 
of stocks and bonds, and $3,125,000,000 of income, paying a 
Federal tax of about $27,000,000. For the fiscal year 1910-11 
the figures had risen to 270,000 corporations, with more than 
$88,000,000,000 of stock and bonds, and $3,360,000,000 of 
income, paying a federal tax of $29,432,000. As the total wealth 
of the United States has been estimated at $125,000,000,000, it 
would appear that nearly two-thirds of it is held by corporations. 

263 



THE CAREFUL INVESTOR 

Approximately one-third of this immense mass 
of seciirities represents promises to pay gold at 
various dates in the future, and the value of the 
commodity which these bonds promise to pay is 
falling with every advance in the average price 
of other commodities. Standard railroad bonds 
which, fifteen years ago, were selling on a 3>^ per 
cent, basis, have now fallen in price until they 
yield between 4X 3,nd 4^^ per cent., and their 
decline is persistent. During the past year, the 
decHne in the prices of all kinds of bonds has been 
noteworthy. Every variety of bonds — ^railroad, 
industrial, municipal — ^has suffered from the de- 
predation of investments. 

On the other hand, this same period which hats 
witnessed such a marked decline in the value of 
bonds has shown an even more pronounced ad- 
vance in the prices of stocks. The average price 
of 36 standard railroad and industrial stocks in 
1896 was $62.50; in May, 191 2, this average 
price had almost doubled, rising to $118. The 
reason is as follows : A share of stock represents 
a right to participate in the distribution of profits 
of the corporation. These profits tend to increase 
during periods of rising prices, because the costs 

of production and distribution, including a large 

264 



THE INVESTOR AND GOLD SUPPLY 

amount of fixed expense, as, for example, interest, 
depreciation, etc., do not advance to correspond 
with the increase in the selling value of the prod- 
uct. Every business which depends upon the sale 
of a commodity has felt the stimulating influence 
of rising prices. Even the public-service corpora- 
tions, whose prices and rates are fixed by law and 
custom — the railroads, street-railways, gas, elec- 
tric light, and water companies — ^have profited 
enormously from the immense business which the 
advance of prices has so greatly assisted to pro- 
duce. It is no wonder, therefore, that the prices 
of the stocks which promised their holders partici- 
pation in this recent flood of industrial profits 
should have scored such rapid advances. 

Here, then, is the situation. The advance of 
prices shows no sign of stopping. With ever}^ 
increase in commodity prices, the purchasing power 
of gold declines. Every form of corporate debt, 
every variety of bonds, is a promise to pay this com- 
modity which is so rapidly depreciating in value. 
Of necessity, therefore, prices of bonds decline as 
the prices of commodities advance. On the other 
hand, rising prices mean rising profits, and the prices 
of stocks which participate in those rising profits 

advance far more rapidly than bonds decline. 

265 



THE CAREFUL INVESTOR 

The conclusion is inevitable, and Mr. Price has 

no hesitation in emphasizing it in the strongest 
possible terms. If the advance of prices is to con- 
tinue, the investor should discriminate against all 
bonds, mortgages, and notes which are simply 
contracts to deliver at a future date so many 
grains of gold, since the purchasing power of that 
gold is constantly diminishing, and should prefer 
agricultural, timber, and mineral lands, and cor- 
poration stocks. In other words, if the deprecia- 
tion of gold is to continue, the prices of bonds 
must persistently depreciate. Any one buying a 
security carrying a fixed income, whether a bond 
or a preferred or guaranteed stock, must face the 
probabiHty of a fall in the price of his investment. 
On the other hand, those who put their money 
into property or certificates of interest in corpora- 
tions which give them the right to participate in 
the profits of industry, can look forward to a 
steady appreciation in the money value of their 
investments. 

These statements challenge attention. I have 
stated them in the baldest possible manner, so 
that the issues which they raise can be set forth 
with entire distinctness. If the depreciation of 
gold continues, bonds must come down and 



THE INVESTOR AND GOLD SUPPLY 

stocks must rise. If a survey of the situation 
shall lead us to the conclusion that the deprecia- 
tion of gold will at no distant date work its own 
remedy in arresting the increase in the produc- 
tion of gold, then these pessimistic utterances 
can be subject to the moderating influence of a 
heavy discount. 



XXIII 
PRICE MOVEMENTS SINCE 1865 

In the previous chapter we reviewed the pessi- 
mistic conclusions expressed by Mr. Theodore H. 
Price concerning the future of bond prices. These 
conclusions are, in effect, that the prices of fixed 
interest bonds w^ill continue to decline, while the 
prices of commodities and land will continue to 
advance, and they are based upon the assumption 
that the supply of gold will continue to increase 
for an indefinite period. 

In order to see what basis there is for this 
conclusion, it is necessary to examine into the 
history of gold production and prices. This is 
not the first experience the world has had with 
high prices. In fact, the prices of 191 1, measured 
by the quotations of forty years ago, are extremely 
moderate. The highest prices ever reached since 
accurate records have been kept were in 1873, 
when the average of 45 staple articles of com- 
merce stood at III per cent, of the average from 
1867 to 1877, which was taken as the standard. 

From this point, during the next twenty years, 

268 



PRICE MOVEMENTS 

prices rapidly declined, until in 1896, when the 
lowest point was reached, they stood at only 
61 per cent, of the standard, a decHne of 50 points 
in twenty-three years. 

This fall of prices was primarily due to a marked 
falling-off in the production of gold, which began 
in 1865, and continued imtil the lowest point was 
reached in 1883. While the output of gold mines 
was declining, industry and trade continued to 
advance, and the result was a very large increase 
in the demand for gold falHng upon a stationary 
or declining supply. Prices, therefore, suffered 
the serious decline already indicated. This fall 
of prices coincided with a series of disastrous 
commercial panics, followed by periods of long 
depression, in which bankruptcies were ntimerous, 
the number of tmemployed large, prices declining, 
and trade stagnant and depressed. During this 
period, the question of the fall of prices agitated 
the world even more than the difficulties con- 
nected with the rise of prices perplex it to-day. 
Here and there a man of intelligence was found 
to express the opinion that the fall of prices was 
a benefit, but the consensus of opinion was that 
it was an unmitigated evil. 

Writing in the Journal of the Royal Statistical 
269 



THE CAREFUL INVESTOR 

Society for September, 1886, Mr. Augustus Sauer- 
beck, who has long enjoyed the reputation of the 
world's greatest price-statistician, siimmed up the 
situation as follows: 

A decline of prices, so far as occasioned by a reduction in tlie 
cost of production, is a decided advantage for the consumer, as 
his principle will always be, "the cheaper the better." The 
lower classes have therefore improved their position, as wages 
have only moderately fallen, while they can buy most of their 
requirements at lower prices. Altogether, they are much better 
ofiE than in the first half of the century, and what was formerly 
considered a luxury forms now part of their daily wants. 

If we, however, say "the cheaper the better," we must not 
forget that "cheap" is a relative expression, and cannot mean 
"the lower the better." If all prices, or the prices of most of 
the principal articles, fall, then it is a distinct disadvantage to 
all producing classes; they either lose heavily or have their 
profits curtailed. Capital is reduced, or does not increase at the 
usual ratio, and ultimately the loss to the whole community 
must be much greater than any small advantage to the consumer. 

A real benefit is only derived by the classes with fixed incomes, 
and by capitalists possessing consols and similar safe investments, 
who can buy more commodities with their income. Many, how- 
ever, had their interests reduced by one per cent., and their 
income, therefore, say, by 20 to 25 per cent. . . . 

Producers have been the severest sufferers, and particularly 
those of agricultural produce, who had to sustain the strong 
competition of cheap soil in extra-European countries, which 
became more effective by the reduction of freight and charges. 
The consequence was a general decline in the value of land. . . . 

The ultimate range of prices is, on the whole, immaterial, as 
it is not prices, but quantities, which keep people employed; but 
it is not at all irmnaterial how prices move, and every strong 
decline is accompanied by a severe crisis. The income is reduced, 

270 



PRICE MOVEMENTS 

and people find it difficult or impossible to retrench, particularly 
if luxury has increased during a period of great prosperity. It 
is the period of transition under which we suffer, and when this 
is passed we may again expect better times. 

The better times which Mr. Sauerbeck pre- 
dicted did not arrive for ten years after the article 
from which the above quotation was taken ap- 
peared. The depression which he portrayed in 
such moderate terms continued to spread, with 
only occasional respites, caused by boimtiful 
crops or some similar temporary relief, until 1896. 

Contrary to the belief generally held, that the 
investor profited by this decline of prices and the 
resulting depression, the reverse was the case. 
The investor suffered quite as severely as any 
other class. As prices declined, the profits of 
industry diminished, and the margin of security 
which is found, not in the case of productive 
property, but in its profitableness, rapidly dimin- 
ished. At intervals, as a result of this decline in 
profits, came wholesale outbreaks of bankruptcy, 
in which the soundest and strongest corporations 
were carried down to ruin, inflicting enormous 
losses upon investors. Bond-holders and stock- 
holders alike were involved in this catastrophe. 

This was the period which saw the bankruptcy 

271 



THE CAREFUL INVESTOR 

of the Union Pacific, the Northern Pacific, the 
Reading, and the Atchison, Topeka and Santa Fe. 
Ten years before their failures, which followed the 
panic of 1893, four of these five railroads were 
ranked among the strong railroad enterprises of 
the country. Their failures affected bond-holders 
and stock-holders alike. 

The security of bonds was weakened by the 
decline of prices, and the investor found slight 
compensation in the advance of the prices of those 
of his holdings which survived the shock for the 
impairment of his security. At the same time, 
when he came to invest his surplus income in any 
security, the number of staple investments, owing 
to the persistence of depression and bankruptcy, 
was so much reduced as to carry the prices of 
strong investments to figures at which they 
yielded between 3 and 3>^ per cent, on the pur- 
chase price. It is a mistaken notion that the 
investor profits during periods of falling prices. 
He suffers in common with the rest of the com- 
munity. Falling prices, due to a scarcity of gold, 
are an evil. A downward movement of prices 
blights enterprises, discourages producers, and 
injures the investor in hardly less degree. 

It is from this industrial slough of despond 

272 



PRICE MOVEMENTS 

that the large increase in gold-production, which 
began in 1886, and has continued until the last 
few years, has rescued the civilized world. The 
past ten years have been years of world-wide 
and abounding prosperity, in which every class 
has participated. It is true that real wages — 
that is, the purchasing power of money wages 
over the necessaries of life — ^have declined, but, 
on the other hand, the aggregate of wages re- 
ceived, owing to the abundant opportunities for 
employment, has been far greater than it was 
during the low-priced years which preceded. The 
producing classes have everywhere prospered. 
The value of land has greatly advanced, and the 
farmer in every country in the world has estab- 
lished his financial position on a basis of prosperity. 
The investors have also profited. In so far as 
they held stocks, they have seen these stocks rise 
to high figures. If they held mortgages, they 
have had these mortgages promptly paid, in strik- 
ing contrast to the frequent necessity of fore- 
closure which characterized the years following 
the panic of 1893. If the security of their bonds 
had been impaired by the previous years of de- 
pression, the years of prosperity have repaired the 

damage done, and elevated to the class of sound 
18 273 



THE CAREFUL INVESTOR 

investments a very large number of railroad and 
industrial investments, whose previous reputation 
had been bad. The rise of prices, and the spread 
and permanence of industrial prosperity, have also 
brought before the investor large numbers of 
issues, as, for example, timber bonds and mining 
bonds, which, during periods of depression, it 
would not be safe for him to touch. These new 
securities, together with the large and growing 
class of public utility bonds, offer him rates of 
income far greater than those which were open to 
him in safe investments twenty years ago. If the 
investor has suffered in the depreciation of high- 
grade securities in recent years, he has obtained 
compensation several times over in increased op- 
portimities for investment at higher rates of inter- 
est and the increased security of his holdings. 



XXIV 
INVESTOR AND THE FUTURE OF PRICES 

Every one who discusses the price question 
takes it for granted that prices will continue to 
advance, borne up on a constantly rising money- 
supply. As the prices of commodities go up, the 
prices of bonds, and all other forms of fixed interest 
investment will decline. The purchasing power 
of salaries, rents, etc., will fall, the assets of large 
investment institutions will be depleted, and the 
investing class, generally, will suffer severe losses. 
On the other hand, it is urged that the advance 
in prices of commodities will put up the prices of 
stocks, and all forms of property except loans, 
rental investments, or annuities. The conclusion 
drawn from this prediction is that the investor 
should discriminate against bonds and in favor of 
stocks and real property. 

If, however, it appears upon examination that 

there is no warrant for believing that the supply 

of gold will continue to increase as it has in the 

past; if we reach the conclusion that the gold 

supply will advance much less rapidly in the next 

275 



THE CAREFUL INVESTOR 

two decades than it has in the past, it is safe to 
predict that prices will not go much higher. 

Before taking up the question of the future 
supply of gold, let us look for a moment at the 
other side of the price ratio. A large part of the 
advance in commodity prices has been due to the 
pressure of population upon the means of sus- 
tenance. In 1890, thirty-six out of every htmdred 
inhabitants of the United States lived in cities 
and towns of more than 2,500 inhabitants. In 
1 9 10, the percentage of city and town dwellers 
had increased to forty-six. The population of the 
cities during this twenty-year period rose from 
22,700,000 to 46,600,000, while the poptdation of 
the farms rose from 40,237,000 to 49,348,000. 
This is a gain of 20,000,000 people for the towns, 
and 9,000,000 for the farms. In other words, 
the consumptive demand for food-products is 
increasing much more rapidly than the number 
of people available to produce the food. 

An examination of the yield of our principal 
cereal crops confirms this conclusion. In 1889 
there was- a record corn-crop in the United States, 
and the total production reached 2.1 billion 
bushels. By 191 1 the production had risen only 
to 2.5 billion bushels. The yield per acre in 1889 

276 



INVESTOR AND FUTURE PRICES 

was 27 bushels, and in 191 1 about 24 bushels. 
The wheat-yield of the United States in 1889 was 
490,000,000 bushels, and in 191 1, 621,000,000 
bushels. The yield per acre was almost the same, 
12.9 bushels in 1889 and 12.5 bushels in 191 1. 

The statistics of farm animals make even a 
more disastrous showing. In 1890 there were 
57,648,000 cattle on American farms; in 191 1 the 
number had increased only to 60,502,000, al- 
though the total population of the coimtry during 
the same period had risen from 62,947,000 to 
91,972,000. The showing for hogs is but little 
better: 50,625,000 in 1890, and 65,620,000 in 1911. 

These few comparisons prove conclusively that 
one cause of the advance of prices has been the 
diminishing yield from the farms, at a time when 
the demand for food-stuffs was greatly increased 
by the growth in city population. It is unreason- 
able to suppose that this condition will be allowed 
long to continue. Farming is, at the present time, 
the most profitable American industry, and yet 
American farms, if cultivated with intelligence 
and with sufficient capital, could easily double 
their yield. It is a poor farm that cannot show 
50 bushels of com to the acre, and yet the average 

for the United States is less than 24 bushels. A 

277 



THE CAREFUL INVESTOR 

yield of 20 bushels of wheat to the acre, with 
ordinary cultivation and care, is not excessive. 
The average yield for the United States, however, 
is only 12. Yields of oats from 50 to 60 bushels 
to the acre are very commonly secured by intelli- 
gent and competent farmers. The average yield 
for the United States is only 24.4 bushels. 

The widespread agitation of this subject of 
rising prices of farm-lands, and the growing 
interest of all classes in the problem of food-supply, 
is certain to result in a very great increase in the 
production of agricultiural products during the 
next decade, and it is a reasonable presiunption 
that farm products will be lower as a result. 
While the yield from farms already in cultivation 
will increase, enormous areas of new land are 
being opened up. The completion of the Grand 
Trunk Pacific in Canada is certain to make large 
additions to the wheat supply. The agricultural 
area of the Argentine Republic is rapidly ex- 
panding, stimulated by the enormous profits to 
be gained from wheat-growing. Agriculture, the 
world over, is feeling the stimulus of high prices 
and immense profits. The natural consequence 
will be a continued increase in the supply of food- 
stuffs, and fall in their prices. 

278 



INVESTOR AND FUTURE PRICES 

Space does not permit a review of the corre- 
sponding developments in other lines of raw- 
material production. It is sufficient to point out 
that the production of coal, iron, wool, cotton, 
copper, and, indeed, all of the materials of in- 
dustry, is advancing rapidly, and that the tendency 
everjnvhere seems to be toward lower prices as 
a result. 

What now of the gold supply? Are we war- 
ranted in believing that the supply of gold will 
continue to increase, and that its value will pro- 
gressively decline? It is impossible, on the basis 
of an examination of the history of gold-produc- 
tion, to reach such a conclusion. On the con- 
trary, the indications are abundant that gold- 
production for the next few years has nearly, if 
not quite, reached its maximum, and that the 
production will continue to decline. 

Gold has a fixed price — $20.67 an ounce. The 
gold-miner is producing money. Out of his daily 
production, he must pay his expenses. He buys 
labor, timber, drill steel, candles, lubricating oil, 
quicksilver, wood, sulphuric acid, salt, scrap iron, 
and rope, in addition to large amounts of machin- 
ery. He also hires a variety of skilled labor, 
besides many unskilled workmen. The lower 

279 



THE CAREFUL INVESTOR 

the prices of these materials and the lower the 
wages of labor, the larger will be the margin which 
remains out of his daily production of money. 

When prices fall, and when labor is cheap and 
abundant, this margin is large. As a result, the 
gold-miner makes large profits; investors are 
anxious to put their money in his business. 
Prospectors are active in discovering new deposits. 
The annual production is extended to ores yield- 
ing, in some cases, less than $3.00 a ton. A large 
increase in the output of gold is the result. When 
prices are rising, however, the margin of the gold- 
miner's profits is reduced. The rising prices, 
which increase the profits of other industries, 
compel him to pay more for his labor. The 
investor's money is directed into other channels 
than gold-mining. The prospecting activities, no 
longer stimulated by lack of opportimity for 
employment, on the one hand, and by the glit- 
tering prizes of discovery on the other, slacken. 
The gold-miner is forced to abandon the immense 
bodies of low-yield ore. As a result, gold-pro- 
duction declines. 

This movement is at present taking place in 
every gold-mining coimtry. Those who are 
coimting on an increase in the production of gold 

280 



INVESTOR AND FUTURE PRICES 

should examine the statistics of gold-production 
in the United States. The principal gold-mining 
States are Alaska, California, Colorado, Mon- 
tana, Nevada, South Dakota, and Utah. Of 
these seven States, only one shows any large 
increase in gold production, the State of Nevada, 
due to the development of a few camps of extra- 
ordinary richness. The production in Alaska, 
which was $18,000,000 in 1907, in 191 1 was only 
$16,000,000. Colorado in 1905 produced $25,000,- 
000 of gold; in 191 1 only $19,000,000. The pro- 
duction of Montana, during the same period, fell 
from $5,000,000 to a little more than $3,000,000. 
South Dakota about held its own. The produc- 
tion of Utah seriously declined. The production 
of Nevada, during the same period, rose from 
$5,000,000 to $19,000,000, and the production 
for the United States increased from $88,000,000 
to $96,000,000, an increase due to the phenomenal 
discoveries in a single State. 

These figures show that the gold-mining indus- 
try, taking the Western coimtry as a whole, is 
declining, the natural inference from the extra- 
ordinary prosperity in competing industries 
throughout this section. Even taking the figures 

for the entire world, there is no reason to anti- 

281 



THE CAREFUL INVESTOR 

cipate a continuance of the rate of increase. In 

1906 the total production of the world was $402,- 

000,000. Five years later it was $455,000,000. 

These annual increases in production, it must 

be remembered, are added to a stock of gold 

which has now reached immense proportions, so 

that the percentage of increase is small. It must 

also be remembered that the demands for money 

are rapidly increasing — ^increasing, indeed, far 

more rapidly than a gain of ten or fifteen million 

dollars a year can satisfy. Take, for example, 

the national banks of the United States, In 1900 

these banks held in specie $373,000,000, nearly 

all of this being gold. In 191 1, twelve years 

later, the specie holdings had increased to $711,- 

000,000, more than double the former amoimt. 

Every time a new bank is organized, and the 

nimiber is rapidly increasing, a certain amoimt 

of money must be withdrawn from circulation 

and put into that bank's reserve. This represents 

an increasing demand upon the world's money 

supply. What is going on in the United States 

is but typical of development in other coimtries. 

Canada and South America are rapidly enlarging 

their banking reserves. Immense amoimts of 

gold will be sent to China to assist in the industrial 

282 



INVESTOR AND FUTURE PRICES 

development of that country. The final settle- 
ment of the Turkish problem will open the re- 
sources of the Balkan Peninsula to exploitation, 
and large amounts of money will be required to 
carry on this new business. In every part of the 
world, in vast regions, imtil recent years im- 
touched by civilization, railroads are being con- 
structed, mines opened, farms developed, and 
money — that is, gold — ^required. 

In view of the small increases in the annual 
production of gold, and in view also of the cer- 
tainty that the next decade will see large increases 
in the production of commodities and in the 
demand for money, it is unreasonable to expect 
that prices will much longer continue to increase. 
The investor who has been discouraged by a 
decline in the prices of his fixed interest securities, 
and who has been tempted to sell them out at a 
sacrifice, or to exchange them for bonds of less 
merit, but higher yield, will do well to remember 
that economic history always repeats; that there 
have been periods of rising prices in the past, 
and that these have always been followed by other 
periods when prices were declining and bonds 
increasing in value. 



283 



INDEX 



Accurate predictions difficult, 29 
Agriculture, need of investment in, 

200 
American Railway Securities, 115 

equipment, 117 

expenditures, 116 

explanation of decreasing output, 
116 

freedom from competition, 122 

Pennsylvania Railroad compared 
with U. S. Steel Corp., 120, 121 

profits, 118, 119 

size of plant and personnel, 117 

stability of demand for service, 
122 
American Sugar Refining Co., 42 
Analysis of issuing company, 68, 69 
Anthracite strike, 1902, 211 
Argentine Republic, expanding in 

agricultural area, 278 
Ashley, Michigan, invalid issue, 103 
Atchison, Topeka & Santa Fe, 14, 
16, 17 

bankruptcy, 272 
Audit of corporation books, 69 

example, 86, 158, 159 

Bad investment losses, 37 
Baltimore & Ohio, bankruptcy, 212 

profits, 138 
Bank examiners, 19 
Bankruptcies, Atchison, Topeka & 
Santa Fe, 272 

Baltimore & Ohio, 212 

Eastern Railroad Co., illustration, 
22 

Lombard Investment Co., 204 

McCrum-Howell Co., 236-240 

Northern Pacific, 272 

Reading Ry., 272 

Union Pacific, 272 



Board of Directors, 42 

Board of Supervising Engineers, 169 

Bondholders, rights of, 59 

superior position of, 45-47 
Bond house, work of, 49 
Bonds, definition, 38 

of going concerns, 39 

how to buy, 48 

in default, 46 

invalid issues, 103 

stability of prices, 47 
Bond values, decline, 264-266 
Bradstreet's compilation of whole- 
sale prices, 106 

commodities, 262 
Breach of trust, 18 
Brokerage houses, inspection of, 19 
Buffalo, Rochester & Eastern R, R., 

example, 181, 182 
Burke, Edmund, 98 
Byllesby, H. M., 66 

Capital stock increasing, 43 
Carnegie, Andrew, 254 
Centralized management, 258 
Cereal crops, jdeld, 276 
Chamberlain, Lawrence, 106 
Chewing gum, illustration, 24 
Chicago Railways Co., illustration, 

167, 168 
China, industrial development of, 282 
Choice of securities, 36 
Clive, Lord, 129 
Commissions, 14, 26 
Commodity prices, 262, 276 
Competition, 122, 212, 213 

e^dls of, 254-256 
Consolidated Gas Co. of N. Y., 

opinion, 148, 150 
Constitution of U. S., eleventh 

amendment, 93 



285 



INDEX 



Construction sjTidicates, 68 
Consumptive demand, increasing, 

276 
Convertible debentures, illustration, 

32 
Cooperative buying, 77 

methods, 254, 255 
Corporate deed of trust, form, 54 
Corporation bondholder, 40, 52 
Corporation mortgage, covenants, 56 

default, 58 
Cost of living problem, 199 
Cost of production, 257 
Crop failures, 31 
Curtice, Mr. Justice, 95 
Cut-throat competition, 254 

Dean, Maurice B., 103 

Defaults, remedy, 113 

Demand greater than population, 146 

Depreciation in bond prices, 263 

in public service issues, 159 
Depression in United States, 1908, 43 
Direct offering, 155 
Direct ownership of bonds, 48 

objections to, 48 
Dissolution of Standard Oil Co., 252, 

253 
Di^-idend paj-ing stocks, 24 
Dividends, 42 

Eastern Railroad Co., bankruptcy, 

illustration, 22 
Economies of combination, 258-260 
Election of directors, 41, 42 
Eleventh amendment of Constitu- 
tion of U. S., 93 
Engineers' investigations, 63-66, 68, 
157 

Farm animals, statistics, 277 
lands, rising prices, 278 
mortgage, advantages, of, 185 

definition, 185 

disadvantages, 188, 189 

increase in values, 198 



Farm mortgage, method of making, 
192-201 
mortgage broker, work of, illus- 
tration, 191, 192. 201, 202 
provisions, 187 
value of farm property. United 

States, 197 
j-ields, diminishing, 278 
Farms as a basis of investment, 197 
number and acreage in U. S., 198 
Faulty investigation, 63-66, 88 
Floating debts, 241, 242 
Fluctuations in stocks, 47 
Food products, consumptive demand 

increasing, 276 
Franchises, bankruptcy, 166 

Chicago Railways Co., illus., 167, 

168 
Board of Supervising Engineers, 

169 
excessive capitalization, 164 
New York city, illustration, 174 
obligations of public, 175 
Philadelphia transit problem, 170- 

174 
prices reduced, 165 
public sentiment, 166 
rights of pubUc, 175 
taxes laid, 165 
Fundamental conditions, 27 
crops, 27 
earnings, 27 
interest rates, 27 

Gambling, profitableness of, 26 
Garj% Elbert H., 254, 255 
Gas industrj-, New York, 147 
Gilt-edge bonds, 263 
Gold, fixed price, 279 

margin of profit, 278, 280 
miner, profits of, 280 

new discoveries, 280 
mining statistics (U. S.), 281 
industry declining, 281 
world's production, 282 



286 



INDEX 



Gold production — Bradstreet's com- 
pilation, 262 
effect upon prices, 261, 268, 269 
falling off in production, 269 
increase in production, 273 

Grand Trunk Pacific in Canada, 278 

Grant in Trust clause, 54 

Great Northern and Northern 
Pacific, 152 

Habendum clause, 54 
Havemeyer, Henry O., 42 
Hill, James J., 200 

Income of American people, 36 
Increase in railway expenses, 124 
Impending shortage of railway 

equipment, 124 
Industrial bonds, 206 

caution in purchasing, 206 

classification, 206 

compared with railroad bonds, 207 

security of, 206 
Industrial corporations, notes and 

paper outstanding, 241 
Industrial preferred stocks, 233 

effect of unwise financial manage- 
ment, 241 

investigations, 233 

McCrum-Howell Co. failure, 236- 
240 

rank after all forms of indebted- 
ness, 236 

restrictions and safeguards, 235, 
236 

speculative investments, 242, 243 
Industrial prosperity, 273, 274 

trust movement, 232 
Inspection of brokerage houses, 19 
Instalment plan of purchasing 
stocks, 34, 35 

illustration, 35 
Insurance companies' investments, 49 
Interstate Commerce Commission, 
134, 135 

rate advances, 124-129, 141 



Interstate Commerce Commission, 
"Reasonable return," 136 
Trunk fine petition, 134, 135 

Invalid bond issues, 103 

Investigation methods, 67 
faulty, 63, 88 

Investment banker, advantages of 
dealing with, 75 
advantages of association in same 

line of trade, 76 
cooperative buying, 77 
expjensive operations of, 74 
guaranty, 85 
losses and defaults, 83 
protection of customers, 87-90 
quality of bonds offered, 80-82 
record of flotations, 91 
safety of bonds purchased from, 84 
superior advantages, 77, 78 
use of credit, 76 
work of, 61-66. 

Labor organizations' demands, 124- 

127 
Law and the broker, 19 

of increasing returns, 144 
Lawyers' statement to bondholders, 

106 
Legal investigations, 69 
Levee district bonds. 111 
Location of manufacturing industry, 

217 
Lombard Investment Co., failure, 

204 
Losses in speculation, 33 
Lumber industry, changes in, 224 

consumption in U. S., 222, 223 

extent of operations, 225 

organization of, 224 

standing timber in U. S., 223 

McCrum-Howell Company, failure, 

236-240 
Margin speculation, 14, 18, 24 

chances of profit, 21 

safe methods, 19 



287 



INDEX 



"Matching" orders, 29 
Monopoly of control of raw material, 
215 

example, 148, 149 
Mortgage bank, advantages, 203 

in Germany, illustration, 202 

in United States, 204 

Lombard Investment Co. failure, 
204 

need of, 203 

where found, 203 

work of, 203 
Mortgage bondholder, rights of, 59 

nature of lien, 50-52 

given by business corporation, 58 
Muck-raking magazines, 11 
Municipal Bonds: careful legal 
investigation (Helena, Mont, 
example), 104 

history of in U. S., 100 

Lawrence Chamberlain, 107 

lawyer's statement to bond house, 
106 

levee district, illustration. 111 

remedy in case of default, 113 

restrictions, 100-102, 110 

safety of, 108 

security of, 99 

special assessment bonds, 113 

tax district, illustration. 111 

yields, prevaihng, 1(W 
"Municipal Bonds Held Void," 103 
Municipal ownership ajid operation, 

176 

National banks of United States, 
specie holdings, 282 

Canada, 282 

South America, 282 
Net income of American people, 36 
Newspaper editorials, 12 
New York Central & Hudson River 

Railroad, profits, 138 
New York City transit, illustration, 

174 



New York merchant, illustration, 

27 
Northern Pacific, bankruptcy, 272 
Notes and paper outstanding, in- 
dustrial corporations, 241 

Panic of 1837, 94 
Patent monopoly, 213 
Peckham, Justice, 148 
Pennsylvania Railroad Co., com- 
pared with U. S. Steel Corp., 
120, 121 

freight classification, 210 

profits, 138 
Personal equation, 217 
Philadelphia Exchange, commissions 

26 
Philadelphia Rapid Transit systems, 

143, 170-174 
Pools, 29, 30 
Population, necessity of growth, 156 

increases, 198 
Powers of attorney, 41 
Powerlessness of small stockholders, 

44 
Predictions, difficulty of, 29 
Price movements: decline, 271, 272 

increases, 262 

rising, of operating supplies, 140 

Sauerbeck, 270 

wholesale, 106 
Price, Theodore H., 261-266, 268 
Price, Waterhouse & Co., 159 
Privileges of stockholders, 41 
Professional stock market educators, 

28 
Profit regulation by state, 150 
Profitableness of gambling, 26 
Prosperity of past ten years, 150 
Prouty, Charles A., 134 
Proxies, 41 

Public Service Commissions, Act 
creating PubUc Service Com- 
mission of New York, 178 

attitude of financial interests, 184 



INDEX 



Public Service Commissions, au- 
thority over issues, 178 

Buffalo, Rochester & Eastern, ex- 
ample, 181, 182 

favored by investors, 184 

methods of procedure, 179, 180 

protection of appUcant, 181 

protection of investors, 183 

Wefft Shore & Nickel Plate Rail- 
road Co., illustration, 183 

work of, 177 
Public Sei^rice Corporations, audita, 
158 

bankruptcy, 166 

Chicago Railways Co., illustra- 
tion, 167, 168 

Consolidated Gas case, 150 

demand greater than population, 
146 

depreciation, 159 

direct offering, 155 

dividends, Philadelphia system, 
143 

engineers' examinations, 157 

excessive capitalization, 164 

gas industry, N. Y., 147 

Great Northern and Northern 
Pacific, 152 

law of increasing returns, 144 

monopoly, 148 

municipal ownership and opera- 
tion, 176 

New York city, illustration, 174 

obligations of public, 175 

Philadelphia Transit problemB^ 
143, 170-174 

pledge of property, 155 

population, necessity of growth, 
156 

prosperity, 143 

profit regulation by state, 150 

prices reduced, 165 

property value, 160 

public sentiment, 166 

rigbts of public, 175 



Public Service Corporations, reason- 
able return, 151 
state supervision, 161 
statement of lawyers, 159 
Seattle, example, 156 
Wilcox vs. Consolidated Gas Co., 

148 
yield, 154 
Purchasing power of gold, 265, 266, 
273 

Railroads, building and rebuilding, 
123 

equipment, 124 

expenses, 124 

profits, 138 

proposition to I. C. C, 141 

regulations, 115 

stocks, 24 
Railway Brotherhoods, 124-132 

eflSciency, maximum not reached, 
141 
Raw material, production, 279 
Reading Railway Co., illustration, 27 

bankruptcy, 272 
"Reasonable return," 151 
Reclamation by drainage, 199, 200 
Remedy in case of default, 113 
Repudiation of state debts, 94-97 

illustration, 95 
Rights of mortgage bondholder, 59 
Rule for selecting stocks, 24 

St. Louis & San Francisco default, 83 
Safest investment, 107 
Sauerbeck, Augustus, 270, 271 
Savings banks, investments of, 49, 

109 
School of cooperation, 254, 255 
Schwab, Charles M., 218 
Scientific speculators, 31 
Seattle, example, 156 
Security jobber, 74, 75 
Sherman law, 213, 244, 245, 248 
Shippera' misdeacriptioas, 249, 250 



289 



INDEX 



Short selling, 31 

Speculative investments, 242, 243 
Special assessment bonds, 113 
Standard Oil Co., 244, 248, 249, 251- 

253 
Standard securities, 201, 202 
Standing timber in U. S., 223 
State bonds, 93 

State debts, repudiation, 94-97 
State supervision, 150, 161 
Statement of account with broker, 

illustration, 16, 17 
Stetson, Francia Lynde, 263 
Stock brokerage houses, 11 

inspection of, 19 
Stock Exchanges, abuses, 12 

failures, 18 

proposed abolishment, 12 
Stockholders' privileges, 41 
Stocks, advance in prices, 264-266 

rule for selecting, 24 
Straight, W. E., timber expert, 229- 

230 
Subsidiaries, earn more than pay, 

140 
Suburban Electric Railroad, illus- 
tration, 62-65 
Sugar stock purchase, illustration, 25 
Suit to dissolve company whose 

stock was active, 23 
Supreme court decisions, 244, 248 

Tax district bonds, 111 
Taylor-White process, illustration, 

214 
Timber bonds, basis of security, 222 

consumption of lumber in United 
States, 222, 223 

illustration of Boston house, 227 



Timber bonds, issued against exist- 
ing property, 226 
reqviirements, 227 
W. E. Straight's report, 229, 230 
standing timber in U. S., 223 
Trading a new issue for an old, 

example, 76 
Trunk Line petition, I. C. C, 134, 

135 
Trusts, centralized management, 258 
cost of production, 257 
dissolution of Standard Oil Co., 

252, 253 
economies of combination, 258- 

260 
evils of competition in prices, 254- 

256 
organization of, illustration, 246, 

247 
superiority of cooperative methods, 

254, 255 
Supreme Court decisions, 244, 248 

Union Pacific, bankruptcy, 272 
United States Government bonds, 

93, 251 
United States Steel Corporation, 27, 

120, 121, 213, 215 
Unseasoned bonds, 67 
Unsecured creditors, 19 

Wall Street, methods denounced, 11 
Water Power enterprise, illustration, 

65 
West Shore & Nickel Plate Railroad, 

illustration, 183 
White, Stewart Edward, 224 
Wholesale prices, Bradstreet's com- 
pilation, 106 
Wilcox vs. Consolidated Gas Co., 14 



f 



